-----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, KoAsdgrkDec6M01rU/fRsAQhPHn1bAoriCsNXEE6/Dx4q64jTt/j6xN88cgtE5hr PeWT8EuVKJU24MnMARAZyA== 0000898430-98-004066.txt : 19981118 0000898430-98-004066.hdr.sgml : 19981118 ACCESSION NUMBER: 0000898430-98-004066 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ASSISTED LIVING CONCEPTS INC CENTRAL INDEX KEY: 0000929994 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-NURSING & PERSONAL CARE FACILITIES [8050] IRS NUMBER: 931148702 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13498 FILM NUMBER: 98751139 BUSINESS ADDRESS: STREET 1: 10570 SE WASHINGTON STREET 2: STE 213 CITY: PORTLAND STATE: OR ZIP: 97216 BUSINESS PHONE: 5032526233 MAIL ADDRESS: STREET 1: 9955 SE WASHINGTON, SUITE 201 CITY: PORTLAND STATE: OR ZIP: 97216 10-Q 1 FORM 10-Q ________________________________________________________________________________ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20459 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 12 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition period from ___ to___ Commission file number 1-13498 ASSISTED LIVING CONCEPTS, INC. (Exact name of registrant as specified in its charter) NEVADA 93-1148702 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 9955 SE Washington, Suite 300 Portland, Oregon 97216 (Address of principle executive offices) (503) 252-6233 (Registrant's telephone number, including area code) Indicated by check mark whether Registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrants was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ --- Shares of Registrant's common stock, $.01 par value, outstanding at October 31, 1998 - 17,388,695. - -------------------------------------------------------------------------------- Page 1 of 22 ASSISTED LIVING CONCEPTS, INC. FORM 10-Q SEPTEMBER 30, 1998 INDEX -----
PART I - FINANCIAL INFORMATION Page Item 1. Financial Statements Condensed Consolidated Balance Sheets as of December 31, 1997 and September 30, 1998................ 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 1997 and September 30, 1998............................................................ 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 1997 and September 30, 1998............................................................ 5 Notes to Condensed Consolidated Financial Statements................................................. 6 - 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................ 9 - 21 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders.......................................... 22 Item 6. Exhibits and Reports on Form 8-K............................................................. 22
Page 2 of 22 PART 1 ITEM 1 - FINANCIAL INFORMATION ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31, 1998 ASSETS 1997 (UNAUDITED) ------------ --------------------- Current assets: Cash and cash equivalents $ 63,394 $ 79,773 Funds held in trust 1,956 238 Accounts receivable 2,185 5,096 Other current assets 4,504 7,182 --------- --------- Total current assets 72,039 92,289 --------- --------- Property and equipment 100,751 216,112 Construction in process 103,795 72,011 --------- --------- Total property and equipment 204,546 288,123 Less accumulated depreciation 2,477 5,741 --------- --------- Property and equipment - net 202,069 282,382 Goodwill 13,397 9,597 Other assets 10,800 16,421 --------- --------- Total assets $298,305 $400,689 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 9,873 $ 20,216 Construction payables 18,883 6,840 Construction financing 2,150 -- Current portion of long-term debt 172 1,127 --------- --------- Total current liabilities 31,078 28,183 Convertible subordinated debentures 100,165 161,250 Long-term debt 26,047 65,248 --------- --------- Total liabilities 157,290 254,681 --------- --------- Stockholders' equity: Preferred Stock, $.01 par value; 1,000,000 shares authorized; - - none issued and outstanding Common Stock, $.01 par value; 80,000,000 shares authorized; 15,646,478 and 17,346,312 issued and outstanding in 1997 and 1998, respectively 156 173 Additional paid-in capital 137,379 144,716 Fair market value in excess of historical cost of acquired net assets attributable to related party transactions (239) (239) Retained earnings 3,719 1,358 --------- --------- Stockholders' equity 141,015 146,008 --------- -------- Total liabilities and stockholders' equity $298,305 $400,689 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 3 of 22 ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1998 1997 1998 ------ ------- ------ ------ Revenues 12,505 24,162 32,597 64,458 Operating expenses: General operating expenses 7,897 15,002 20,146 39,727 Corporate general and administrative 691 1,629 2,008 4,077 Building rentals 2,342 3,628 5,212 10,688 Building rentals to related party 353 341 1,052 1,120 Depreciation and amortization 801 1,557 2,009 3,646 Non-recurring charge -- -- -- 8,495 ------ ------- ------ ------ Total operating expenses 12,084 22,157 30,427 67,753 ------ ------- ------ ------ Operating income (loss) 421 2,005 2,170 (3,295) Interest expense (245) (723) (653) (1,376) Interest income 138 1,227 414 2,872 Other income 1,293 1,881 1,775 4,685 ------ ------- ------ ------ Income before income taxes 1,607 4,390 3,706 2,886 Provision for income taxes 611 1,668 1,079 2,477 ------ ------- ------ ------ Net income before cumulative effect 996 2,722 2,627 409 Cumulative effect of change in accounting principle (net of -- -- -- (2,770) tax benefit of $1,187) ------ ------- ------ ------ Net income (loss) 996 2,722 2,627 (2,361) ====== ======= ====== ====== Basic net income (loss) per common share before cumulative .09 .16 .24 .02 effect of change in accounting principle Cumulative effect of change in accounting principle -- -- -- (.16) ------ ------- ------ ------ Basic net income (loss) per common share .09 .16 .24 (.14) ====== ======= ====== ====== Diluted net income (loss) per common share before cumulative .09 .16 .23 .02 effect of change in accounting principle Cumulative effect of change in accounting principle -- -- -- (.16) ------ ------- ------ ------ Diluted net income (loss) per common share .09 .16 .23 (.14) ====== ======= ====== ====== Weighted average common shares outstanding - basic 11,084 17,274 11,018 17,435 Weighted average common shares outstanding - diluted 13,517 17,555 13,492 17,435 - --------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 4 of 22 ASSISTED LIVING CONCEPTS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1997 1998 ------------------- ----------------- OPERATING ACTIVITIES: Net income (loss) 2,627 (2,361) Adjustment to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of asset (36) -- Depreciation and amortization 2,009 3,646 Non-recurring charge -- 8,495 Cumulative effect of change in accounting principle -- 2,770 Changes in assets and liabilities: Accounts receivable, net (1,352) (2,911) Other current assets (1,189) (4,663) Other assets (22) (2,854) Accounts payable and accrued expenses 2,293 6,673 ------------------- ----------------- Net cash provided by operating activities 4,330 8,795 ------------------- ----------------- INVESTING ACTIVITIES: Sale of funds held in trust 6,675 1,718 Acquisitions, net of cash acquired (8,305) Proceeds from sale and leaseback transactions 64,133 8,112 Purchases of property and equipment (110,227) (87,726) ------------------- ----------------- Net cash used in investing activities (39,419) (86,201) ------------------- ----------------- FINANCING ACTIVITIES: Proceeds from short-term construction borrowings 43,210 -- expected to be refinanced Repayments of construction financing (15,370) -- Construction draw 4,749 (12,043) Proceeds from long-term debt 7,350 40,306 Payments on long-term debt (83) (150) Proceeds from issuance of common stock 267 469 Proceeds from issuance of convertible subordinated debentures 75,000 Purchase of common stock (7,030) Debt issuance costs of long-term debt (1,702) (2,767) ------------------- ----------------- Net cash provided by financing activities 38,421 93,785 ------------------- ----------------- Net increase in cash and cash equivalents 3,332 16,379 Cash and cash equivalents, beginning of period 2,105 63,394 ------------------- ----------------- Cash and cash equivalents, end of period 5,437 79,773 =================== ================= Supplemental disclosure of cash flow information: Cash payments for interest 1,823 5,527 Cash payments for income taxes -- 1,438 Extinguishment of construction loan payable with sale -- 2,150 leaseback transaction Convertible debentures converted into common stock -- 13,915
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 5 of 22 ASSISTED LIVING CONCEPTS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Assisted Living Concepts, Inc. and Subsidiaries ("the Company") owns, operates and develops assisted living residences which provide housing to senior citizens who need help with the activities of daily living such as bathing and dressing. The Company provides personal care and support services and makes available routine nursing services designed to meet the needs of its residents. Basis of Presentation These condensed consolidated financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries that manage, own and develop assisted living residences and provide ancillary services such as home health, hospice and durable medical equipment. The condensed consolidated financial statements also include residences the Company owns or leases but are operated through joint venture agreements. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. The financial information included herein reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the nine month period ended September 30, 1997 and 1998 are not necessarily indicative of the results to be expected for the full year. Change in Accounting Principle On April 3, 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). The Company adopted SOP 98-5 effective as of January 1, 1998. The impact of this change in accounting principle ($2,770,000, net of tax) on the Company relates to the treatment of pre-opening costs associated with newly developed residences. SOP 98-5 requires that these costs be expensed as incurred as compared to the Company's previous policy to capitalize these costs prior to commencement of residence operations, amortizing them over a twelve month period. Page 6 of 22 2. PROPERTY AND EQUIPMENT The Company's property and equipment are stated at cost and consist of the following at September 30, 1998 (in thousands): Land $ 14,146 Buildings and improvements 193,528 Equipment 2,449 Furniture 5,989 ----------- Subtotal 216,112 Construction in progress 72,011 ----------- Total property and equipment 288,123 Less accumulated depreciation 5,741 ----------- Property and equipment, net $282,382 =========== As of September 30, 1998, the Company had begun construction on 28 residences (1,110 units) ($69.0 million), which includes 16 residences (633 units) ($30.2 million) that have received a certificate of occupancy, but are pending licensure. As of September 30, 1998, the Company had also entered into agreements pursuant to which it may purchase, subject to completion of due diligence and various other conditions, 22 additional sites. The Company has capitalized $2.4 million of direct costs in conjunction with the due diligence associated with these 22 sites (776 units). The remaining costs are associated with site selection and pre-acquisition activity. 3. CONVERTIBLE SUBORDINATED DEBENTURES Effective August 3, 1998, the Company called for redemption all of its 7.0% Convertible Subordinated Debentures Due 2005. All debentures were converted at a price of $7.50 per share, resulting in the issuance of approximately 1,855,000 shares of common stock. Page 7 of 22 4. NET INCOME (LOSS) PER COMMON SHARE Basic earnings per share (EPS) is calculated using income attributable to common shares divided by the weighted average number of common shares outstanding for the period. Diluted EPS is calculated using income attributable to common shares (after considering the effects of dilutive potential common shares) divided by the weighted average number of common shares and dilutive potential common shares outstanding for the period.
Three Three Nine Nine Months Ended Months Ended Months Ended Months Ended September 30, September 30, September 30, September 30, 1997 1998 1997 1998 ======================================================================== Numerator for basic net income (loss) per share $ 996 $ 2,722 $ 2,627 $(2,361) Effect of conversion of convertible Debentures 166 57 443 (a) ------------------------------------------------------------------------ Numerator for diluted net income (loss) per share $ 1,162 $ 2,779 $ 3,070 $(2,361) ======================================================================== Denominator for basic net income (loss) per weighted average common shares 11,084 17,274 11,018 17,435 7% Convertible Debentures 1,855 11 1,855 (a) Stock Option Dilution 578 270 619 (a) ------------------------------------------------------------------------ Denominator for diluted net income (loss) per weighted average common shares 13,517 17,555 13,492 17,435 ======================================================================== Basic net income (loss) per common share $ .09 $ .16 $ .24 $ (.14) Diluted net income (loss) per common share $ .09 $ .16 $ .23 $ (.14)
(a) In accordance with Statement of Financial Accounting Standards No. 128, "Earnings per share", diluted earnings per share equates basic earnings per share when a net loss has been incurred. 5. STOCK BUYBACK During the nine months ended September 30, 1998, the Company purchased 529,900 shares of its common stock for a total purchase price of approximately $7.0 million in accordance with a stock repurchase plan initiated in May, 1998. As of November 12, 1998 all shares purchased by the Company have been reissued in accordance with such plan. 6. LONG-TERM DEBT During the third quarter, the Company closed on $13.2 million of tax exempt bond financing, secured by seven residences in the state of Ohio, at an all inclusive variable rate of approximately 5% and obtained mortgage financing for three Oregon properties in the amount of $6.6 million at a fixed rate of 7.6%. In addition, in September, 1998 the Company closed on $5.8 million of mortgage financing for one property in South Carolina and one property in Pennsylvania at an interest rate of approximately 8.5% and on $5.3 million financing received through sale leaseback transactions on two South Carolina properties. 7. SUBSEQUENT EVENT During October, 1998, the Company received a commitment for a $25 million secured revolving credit facility, subject to certain conditions and expected to close in December, 1998, with PNC Bank, N.A. as agent and Sun Trust Bank, Central Florida, N.A. as a syndicate member. Page 8 of 22 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW THE COMPANY The Company reported net income of $2.7 million or $.16 per diluted share, on revenue of $24.2 million for the three months ended September 30, 1998. Operating results for the nine month period ended September 30, 1998 include the operating results of 154 residences and the Company's corporate overhead, and are not necessarily indicative of future operating financial performance, as the Company intends to expand its operating base of residences in 1998 and 1999. RESULTS OF OPERATIONS Revenues consist of rentals of units in assisted living residences and fees associated with the provision of services to residents pursuant to contracts with the residents. Operating expenses include (i) residence operating expenses, such as staff payroll, food, property taxes, utilities, insurance and other direct residence operating expenses, (ii) general and administrative expenses consisting of corporate and support functions such as legal, accounting and other administrative expenses, (iii) building rentals and (iv) depreciation and amortization expense. The following table sets forth, for the periods presented, the number of residences and units operated, and the average occupancy rates and sources of revenue for the three months ended September 30, 1997 and 1998. The portion of revenues received from state Medicaid agencies are labeled as "Medicaid state portion" while the portion of the Company's revenues that a Medicaid-eligible resident must pay out of his or her own resources is labeled "Medicaid resident portion". THREE MONTHS ENDED SEPTEMBER 30, 1997 ================================================================================
Stabilized Start-up Total Residences Residences Residences Total ----------------------------------------- Residences operated (end of period) 49 39 88 Units operated (end of period) 1,690 1,526 3,216 Average occupancy rate 94% 51% 74% Sources of revenue: Medicaid state portion 11.5 10.4 11.1 Medicaid resident portion 6.5 4.9 5.9 Private 82.0 84.7 83.0 ------------ ----------- ---------- Total 100.0% 100.0% 100.0% ============ =========== ==========
Page 9 of 22 THREE MONTHS ENDED SEPTEMBER 30, 1998 ================================================================================
Stabilized Start-up Total Residences Residences Residences Total ------------------------------------ Residences operated (end of period) 86 68 154 Units operated (end of period) 3,138 2,726 5,864 Average occupancy rate 92% 50% 73% Sources of revenue: Medicaid state portion 14.1 4.3 10.7 Medicaid resident portion 7.8 2.3 5.8 Private 78.1 93.4 83.5 ------------ ---------- --------- Total 100.0% 100.0% 100.0% ============ ========== =========
The following tables set forth, for the periods presented, the compilation of results from stabilized and start-up and from other ancillary services, including corporate activities. Stabilized residences are defined as those residences which were operating for more than twelve months prior to the beginning of the period or had achieved a 95% occupancy rate as of the beginning of the reporting period and exclude three properties held for sale and one property whose operating lease terminated effective September 30, 1998 for the three month period ended September 30, 1998. Start-up residences are defined as those residences which were operating for less than twelve months prior to the beginning of the period or had not achieved a 95% occupancy rate as of the beginning of the reporting period. COMPILATION OF STABILIZED AND START-UP RESIDENCES THREE MONTHS Ended SEPTEMBER 30, 1997
=================================================================================================================== Stabilized Start-up Corporate & Residences Residences Ancillary Services Total ------------- -------------- ------------------ ----------- Revenue 8,254 4,251 - 12,505 Residence operating expense 4,785 3,112 - 7,897 ------------- -------------- ------------------ ----------- Residence operating Income 3,469 1,139 - 4,608 Corporate overhead - - 691 691 Building rentals 1,786 908 1 2,695 Depreciation and amortization 256 514 31 801 ------------- -------------- ------------------ ----------- Total other operating expenses 2,042 1,422 723 4,187 ------------- -------------- ------------------ ----------- Operating income (loss) 1,427 (283) (723) 421 Interest expense (552) (916) 1,223 (245) Interest income 1 2 135 138 Other expense - - - - Other income - 790 503 1,293 ------------- -------------- ------------------ ----------- Net income (loss) before income taxes 876 (407) 1,138 1,607 ============= ============== ================== =========== Residences operated 49 39 88 Units operated 1,690 1,526 3,216 Average occupancy rate 94% 51% 74%
Page 10 of 22 COMPILATION OF STABILIZED AND START-UP RESIDENCES THREE MONTHS ENDED SEPTEMBER 30, 1998
================================================================================================================================= Corporate & Stabilized Start-up Ancillary Total Residences Residences Services ------------------ ----------------- -------------------- --------------- Revenue 15,891 7,554 717 24,162 Residence operating expense 9,204 5,637 161 15,002 ------------------ ----------------- -------------------- --------------- Residence operating income 6,687 1,917 556 9,160 Corporate overhead - - 1,629 1,629 Building rentals 2,810 1,153 6 3,969 Depreciation and amortization 578 815 164 1,557 ------------------ ----------------- -------------------- --------------- Total other operating expenses 3,388 1,968 1,799 7,155 ------------------ ----------------- -------------------- --------------- Operating income (loss) 3,299 (51) (1,243) 2,005 Interest expense (853) (843) 973 (723) Interest income - 3 1,224 1,227 Other income - - 1,881 1,881 ------------------- ----------------- -------------------- --------------- Net income (loss) before income taxes 2,446 (891) 2,835 4,390 ================== ================= ==================== =============== Residences operated 86 68 154 Units operated 3,138 2,726 5,864 Average occupancy rate 92% 50% 73%
The following table sets forth, for the periods presented, the results of operations for the 51 and 77 residences which were operating for three and nine month periods ended September 30, 1997 and 1998, respectively, in their entirety (in thousands). RESULTS OF SAME RESIDENCES THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1998
================================================================================================================================== Three Three Nine Nine Months Ended Months Ended Months Ended Months Ended Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 ---------------- ---------------- --------------- ---------------- Revenue 11,879 13,744 25,101 27,002 General operating expense 7,320 8,036 14,559 15,483 ---------------- ---------------- --------------- ---------------- Residence operating income 4,559 5,708 10,542 11,519 Building rentals 2,334 2,603 4,998 6,041 Depreciation and Amortization 702 480 862 540 ---------------- ---------------- --------------- ---------------- Other Operating Expenses 3,036 3,083 5,860 6,581 ---------------- ---------------- --------------- ---------------- Operating Income 1,523 2,625 4,682 4,938 Interest Expense (1,406) (821) (1,790) (987) Interest Income 3 1 4 3 Other Income (Expense) 626 (2) (1) (1) ---------------- ---------------- --------------- ---------------- Income before income taxes 746 1,803 2,895 3,953 ================ ================ =============== ================ Residences Operating 77 77 51 51 Units Operating 2,776 2,776 1,778 1,778 Average Occupancy Rate 80% 91% 90% 95%
Page 11 of 22 THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998. Revenues. For the three months ended September 30, 1998, revenues were $24.2 million compared to $12.5 million in the three months ended September 30, 1997, an increase of $11.7 million or 93.2%. The Company had opened or received certificates of occupancy on 170 residences as of September 30, 1998, of which 154 had operating results for the quarter period compared to 88 in the corresponding 1997 period. For the 77 residences which had operated for the entire quarter for both September 30, 1998 and September 30, 1997, revenue increased by $1.9 million or 15.7% from the $11.9 million in the third quarter of 1997. This increase was primarily attributable to average occupancy throughout the two periods. Average occupancy increased 11% to 91% from the corresponding period in 1997 of 80%. The remaining $9.8 million of the increase was due to the new residences which began operating subsequent to September 30, 1997. General operating expenses. General operating expenses were $15.0 million in the three months ended September 30, 1998 compared to $7.9 million in the corresponding 1997 period, an increase of $7.1 million, or 90%. For the 77 residences that operated the entire third quarter of 1997 and 1998, general operating expenses were $8.0 million in the three months ended September 30, 1998, an increase of $716,000, or 9.8%, from the $7.3 million of general operating expenses in the third quarter of 1997. Corporate, general and administrative. Corporate, general and administrative expenses were $1.6 million in the three months ended September 30, 1998 compared to $691,000 in the corresponding 1997 period, an increase of $938,000, or 136%. Corporate, general and administrative expenses increased due to the expansion of the Company's quality assurance and corporate staffing to accommodate the increase in operating residences. Building rentals. Building rentals increased to $4.0 million in the three months ended September 30, 1998 from $2.7 million during the corresponding 1997 period. This increase was due to the increased number of sale and leaseback transactions completed by the Company from September of 1997 through September of 1998. The Company had 71 operating leases as of September 30, 1998 compared to 58 at September 30, 1997. Depreciation and amortization. Depreciation and amortization expense was $1.6 million in the three month period ended September 30, 1998 compared to $801,000 in 1997, an increase of $756,000, or 94.4%. This increase in depreciation and amortization was directly related to the new residences that opened subsequent to September 30, 1997. Depreciation and amortization expense for the 77 residences which operated for the entire third quarter of 1997 and 1998 decreased due to the Company entering into 13 additional same store sale leaseback transactions subsequent to September 30, 1997. Interest expense. Interest expense net of capitalized interest was $723,000 for the three month period ended September 30, 1998 compared to $245,000 in the corresponding 1997 period, an increase of $478,000. The Company's gross interest expense was $3.3 million for the three month period ended September 30, 1998 compared to $1.8 million in the corresponding 1997 period, an increase of $1.5 million. The increase in interest expense is due primarily to the issuance of $86.2 million and $75 million of convertible debentures in October, 1997 and April, 1998, respectively. Capitalized interest for the three month period ended September 30, 1998 was $2.54 million compared to $1.62 million in the corresponding 1997 period, a change of $920,000. Interest income. Interest income was $1.2 million for the three month period ended September 30, 1998 compared to $138,000 in the corresponding 1997 period, an increase of approximately $1.1 million. The increase in interest income is directly related to the increase in available funds as a result of issuance of convertible subordinated debentures in April, 1998. Page 12 0f 22 Other income. Other income was $1.9 million for the three month period ended September 30, 1998 compared to $1.3 million in the corresponding 1997 period, an increase of $588,000. The increase in other income for the three months ended September 30, 1998 relates primarily to an increase in properties covered in a joint venture agreement with an entity that has agreed to bear the economic risk for the residences in exchange for the right to participate in future operating results. Income before income taxes. Income before income taxes for the three months ended September 30, 1998 was $4.4 million compared to $1.6 million during the corresponding period in 1997, an increase of $2.8 million. The increase in net income before taxes is due primarily to a $1.1 million increase in same store results and the remainder due to increased properties. Provision for income taxes. The Company's provision for income tax for the three months ended September 30, 1998 was $1.7 million compared to $611,000 for the corresponding period in 1997. Net income. Net income for the three months ended September 30, 1998 was $2.7 million compared to $996,000 during the corresponding period in 1997. The increase in net income is due to the increase of operating properties for the three months ended September 30, 1998 as compared to the same period last year. NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998. Revenues. For the nine months ended September 30, 1998, revenues were $64.5 million compared to $32.6 million in the nine months ended September 30, 1997, an increase of $31.9 million or 97.7%. The Company operated 154 residences in the 1998 period compared to 88 in the corresponding 1997 period. The additional residences increased revenue by approximately $19 million. The 51 residences in operation in both the 1998 and 1997 periods reported an aggregate increase in revenues of $1.9 million or 7.6% This increase was primarily attributable to increases in both average occupancy and yearly rent increases. General operating expenses. General operating expenses were $39.7 million in the nine months ended September 30, 1998 compared to $20.1 million in the corresponding 1997 period, an increase of $19.6 million or 97.2%. The Company operated 154 residences in the 1998 period compared to 88 in the corresponding 1997 period. For the 51 residences that operated for 1997 and 1998, general operating expenses were $15.5 million in the nine months ended September 30, 1998, an increase of $924,000, or 6.4% from the $14.6 million of residence operating expenses in the corresponding period in 1997. The increase in expenses for these 51 residences is due to the increase in staffing to accommodate the level of care due to higher occupancy percentages. The remaining $18.7 million of the increase was due to the new residences that opened subsequent to January 1, 1997. Corporate, general and administrative. Corporate, general and administrative expenses were $4.1 million in the nine months ended September 30, 1998 compared to $2.0 million in the corresponding 1997 period, an increase of $2.1 million, or 103%. Corporate, general and administrative expenses increased due to the expansion of regional operations as well as corporate staffing to accommodate the increase in operating residences. Building rentals. Building rentals increased to $11.8 million in the nine months ended September 30, 1998 from $6.3 million in 1997. The increase in building rentals is directly related to the increase in the number of leases entered into by the Company between October 1, 1997 and September 30, 1998. The Company had 71 operating leases at September 30, 1998 compared to 58 at September 30, 1997. Building rentals for Page 13 of 22 the 51 residences which operated for the entire period of 1998 and 1997 increased due to the one additional same store operating lease entered into subsequent to September 30, 1997. Depreciation and amortization. Depreciation and amortization expense was $3.6 million in the nine month period ended September 30, 1998 compared to $2.0 million in 1997, an increase of $1.6 million, or 81.5%. The increase in depreciation and amortization is directly related to the additional 66 residences opening subsequent to September 30, 1997. Depreciation and amortization expense for the 51 residences which operated for the entire nine month period in 1997 and 1998, decreased due to 5 same store sale leaseback transactions entered into subsequent to June, 1997. Non-recurring charge. The Company recorded a $8.5 million non-recurring charge during the nine months ended September 30, 1998. This non-recurring charge reduced the goodwill related to the Company's 1997 acquisition of a home health agency whose operations are being scaled back in light of the current legislative and reimbursement environment; establishes reserves for exit costs relating to the home health agency; reduces the carrying amount of certain acquired development sites included in construction in progress which are not being developed due to competitive and market conditions; establishes reserves for certain operating properties that are listed for sale; and, establishes a liability for certain REIT commitment fees related to acquired sites which will not be used in light of favorable financing alternatives. Interest expense. Interest expense net of capitalized interest was $1.4 million for the nine month period ended September 30, 1998 compared to $653,000 in the corresponding 1997 period, a change of $723,000. The Company's gross interest expense was $8.2 million for the nine month period ended September 30, 1998 compared to $5.2 million in the corresponding 1997 period, a change of $3.0 million. The increase in interest expense is due primarily to the issuance of $86.2 million and $75 million of convertible debentures in October, 1997 and April, 1998, respectively. Capitalized interest for the nine month period ended September 30, 1998 was $6.8 million compared to $4.6 million in the corresponding 1997 period, a change of approximately $2.2 million. Interest income. Interest income was $2.9 million for the nine month period ended September 30, 1998 compared to $414,000 in the corresponding 1997 period, a change of $2.5 million. The increase in interest income is directly related to the increase in available funds. Other Income. Other income was $4.7 million for the nine month period ended September 30, 1998 compared to $1.8 million in the corresponding 1997 period, a change of $2.9 million. The $4.7 million in other income for the nine months ended September 30, 1998 relates to properties held under a joint venture agreement with an investment company that has agreed to bear the economic risk for the residences in exchange for the right to participate in future operating results. As of November 5, 1998, there are 17 properties operating under the joint venture agreement. Income before income taxes. Income before income taxes for the nine months ended September 30, 1998 was $2.9 million compared to income before income taxes of $3.7 million during the corresponding period in 1997, an decrease of $820,000. The decrease was a direct result of non-recurring charges of $8.5 million for the nine month period ended September 30, 1998. Excluding the non-recurring charge, income before income taxes increased $7.7 million or 207% as a result of 66 residences added since September 30, 1997. Provision for income taxes. The Company's provision for income taxes for the nine months ended September 30, 1998 was $2.5 million compared to $1.1 million for the corresponding period in 1997. Net income (loss). Net income (loss) for the nine months ended September 30, 1998 was $(2.4) million compared to $2.6 million during the corresponding period in 1997. The decrease in income for the nine Page 14 of 22 months ended September 30, 1998, was the result of positive operating results combined with the effects of non-recurring charges of $8.5 million and a change in accounting principle which resulted in a charge of $2.7 million for the nine months ended September 30, 1998. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Company had positive working capital of approximately $64.1 million including liabilities for construction payables and construction financing. Exclusive of construction related activities, working capital was $70.9 million. Net cash provided by operating activities was approximately $8.8 million during the nine month period ended September 30, 1998, and related primarily to the positive results of residence operations. Net cash used for investing activities totaled $86.2 million during the nine month period ended September 30, 1998. The primary use of cash was $87.7 million related to the development of new assisted living residences. Net cash provided by financing activities totaled $93.8 million during the nine month period ended September 30, 1998. The primary source of funds was from the issuance of $75 million of convertible subordinated debentures in April, 1998 and $40.3 million in mortgage financing received during the third quarter. Capital expenditures for the next twelve months are estimated to approximate $104 million to $130 million, related primarily to the development of additional residences. The Company intends to use the funds from the issuance of the $75 million of convertible subordinated debentures in conjunction with future working capital resources to develop additional residences. In addition, as of November 14, 1998, the Company had approximately $60 million in outstanding commitments in REIT and mortgage financing available to finance additional residences. The Company does not anticipate any significant capital expenditures within the foreseeable future with respect to the residences developed since 1994 and those currently operating or those pending licensure as of September 30, 1998. The Company expects that its cash on hand, together with cash flow from operations and available REIT and mortgage financing, will be sufficient to meet is operating requirements and to fund its anticipated growth for at least the next twelve months. In addition, the Company has a number of unencumbered residences that are currently operating or under development that may be leveraged in order to obtain additional funds. The Company expects to use a wide variety of financing sources to fund its future growth, including public and private debt and equity, conventional mortgage financing, unsecured bank financing, among other sources. There can be no assurance that financing from such sources will be available in the future, or if available that such financing will be available on terms acceptable to the Company. As of September 30, 1998, the Company had invested excess cash balances in short-term certificates of deposit and U.S. Treasury securities. RECENT ACCOUNTING PRONOUNCEMENTS Page 15 of 22 In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The adoption of this Statement will not have a material impact on the Company's consolidated financial statements. RISK FACTORS Except for the historical information contained herein, the matters discussed herein are foreword looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The following discussion highlights some of these risks and others are discussed elsewhere herein or in other documents filed by the Company with the Securities and Exchange Commission. ANTICIPATED OPERATING LOSSES OF NEW RESIDENCES. The Company anticipates that each residence will have an operating loss (prior to depreciation, rent or interest, if any) of $20,000 during the first three to four months of operation. To the extent the Company sells a residence and leases it back or otherwise finances it, the aggregate loss may increase by up to an additional $100,000. The Company currently plans to open 40 to 50 residences during the next twelve months. The Company estimates that the losses to be incurred during the next twelve months due to start-up residences could range from $850,000 to $2.75 million. The success of the Company's future operations is directly tied to the expansion of its operational base. There can be no assurance that the Company will not experience unforeseen expenses, difficulties, complications and delays in connection with the expansion of its operational base which could have a material adverse effect on the Company's financial condition and results of operations. In April 1997, in order to mitigate the impact of start-up losses associated with the opening of newly constructed residences, the Company entered into a joint venture agreement with a third party investor to operate certain new assisted living residences owned and developed by the Company. The joint venture concurrently entered into a non-cancelable management agreement with the Company pursuant to which the Company will manage the properties operated by the joint venture for an amount equal to the greater of 8% of gross revenues or $2,000 per month per property. As of November 5, 1998, seventeen residences owned or leased by the Company were being operated by the joint venture. During the three months ended September 30, 1998, the Company operated twenty-eight properties under the joint venture, of which the Company bought out the joint venture partner's interest in eleven properties subsequent to September 30, 1998. The Company anticipates 5 to 10 new residences will enter the joint venture per quarter. The revenues and expenses of the joint venture are consolidated with those of the Company. In addition, the Company will recognize 10% of the losses or profits, if any, of the joint venture, net of the effect of management fees paid to the Company. The Company may seek to acquire the joint venture partner's 90% interest in the future, but has no contractual right to purchase such interest. While the use of such joint venture agreements is intended to mitigate the impact on the Company of start-up losses associated with the opening of new residences or otherwise, the Company may, to the extent it does not acquire the partner's interest, forego a portion of future operating profits, if any, from the residences operated by the joint venture. The Company expects it will, from time to time, enter into additional partnering arrangements, Page 16 of 22 which may be similar to the current structure, for some of its future development projects. There can be no assurance that the Company will be able to enter into any such future arrangements or, if entered into, that such arrangements will achieve the desired results. Due to the completion of debt and equity financings, the Company expects to own a higher percentage of its residences. Historically, the Company has relied extensively on sale/leaseback financings from REITs to finance its development efforts. The Company expects to make additional investments in its management infrastructure to further support its growth strategy. While the Company believes that the resulting effects of the recent completed financings, the increased focus on asset ownership, its development program and anticipated additions to its corporate infrastructure may negatively impact its earnings prospects over the next 12 to 18 months, it believes that these measures will positively affect its long-term prospects. NO ASSURANCE AS TO ABILITY TO DEVELOP OR ACQUIRE ADDITIONAL ASSISTED LIVING RESIDENCES. The Company's prospects for growth are directly affected by its ability to develop and acquire additional assisted living residences. While the Company currently plans to open 40 to 50 residences during the next twelve months, there can be no assurance that such residences will be completed. The success of the Company's growth strategy will also depend upon, among other factors, the Company's ability to obtain government licenses and approvals, the Company's ability to obtain financing and the competitive environment for development and acquisitions. The nature of such licenses and approvals and the timing and likelihood of obtaining them vary widely from state to state, depending upon the residence, or its operation, and the type of services to be provided. The successful development of additional assisted living residences will involve a number of risks, including the possibility that the Company may be unable to locate suitable sites at acceptable prices or may be unable to obtain, or may experience delays in obtaining, necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations. The Company is dependent upon these permits and authorizations to construct and operate its residences and any delay or inability to obtain such permits could adversely affect the results of operations. The Company may also incur construction costs that exceed original estimates, may not complete construction projects on schedule and may experience competition in the search for suitable development sites. The Company relies on third-party general contractors to construct its new assisted living facilities. There can be no assurance that the Company will not experience difficulties in working with general contractors and subcontractors, which could result in increased construction costs and delays. Further, facility development is subject to a number of contingencies over which the Company will have little control and that may adversely affect project cost and completion time, including shortages of, or the inability to obtain, labor or materials, the inability of the general contractor or subcontractors to perform under their contracts, strikes, adverse weather conditions and changes in applicable laws or regulations or in the method of applying such laws and regulations. Accordingly, if the Company is unable to achieve its development plans, its business, financial condition and results of operations could be adversely affected. There can be no assurance that the Company will be successful in developing or acquiring any particular residence, that the Company's rapid expansion will not adversely affect its operations or that any residence developed or acquired by the Company will be successful. The various risks associated with the Company's development or acquisition of assisted living residences and uncertainties regarding the profitability of such operations could have a material adverse effect on the Company's financial condition and results of operations. NEED FOR ADDITIONAL FINANCING TO FUND FUTURE DEVELOPMENT AND ACQUISITIONS. To achieve its growth objectives, the Company will need to obtain sufficient financial resources to fund its development, construction and, to a lesser extent, its acquisition activities. The estimated cost to complete and fund start-up losses for new facilities that will be developed during the next twelve months is between $104 million and $130 million; accordingly, the Company's future growth will depend on its ability to obtain additional financing on acceptable terms. The Company will, from time to time, seek Page 17 of 22 additional funding through public and/or private financing sources, including equity and/or debt financing. If additional funds are raised by issuing equity securities, the Company's stockholders may experience dilution. There can be no assurance that adequate funding will be available as needed or on terms acceptable to the Company. A lack of available funds may require the Company to delay or eliminate all or some of its development projects and acquisition plans. The Company's aggregate annual fixed debt and lease payment obligations as of September 30, 1998 totaled approximately $29.9 million. These fixed payment obligations will significantly increase as the Company pursues its development and acquisition plan. Failure to meet these obligations may results in the Company being in default of its financing agreements and, as a consequence, the Company may lose its ability to operate any individual residence or other residences which may be cross-defaulted. There can no assurance that the Company will generate sufficient cash flow to meet its current or future obligations. The Company has not historically covered its fixed charges with earnings. In addition, there is a risk that, upon completion of construction, permanent financing for newly developed residences may not be available or may be available only on terms that are unfavorable or unacceptable to the Company. GEOGRAPHIC CONCENTRATION; DEPENDENCE ON STATE MEDICAID WAIVER PROGRAMS; DEPENDENCE ON REIMBURSEMENT BY THIRD PARTY PAYORS. As of September 30, 1998, 22.9% of the Company's properties are in Texas, 11.8% are in Oregon, 10.6% in Ohio, 10.6% are in Indiana and 9.4% in Washington; therefore, the company is dependent on the economies of Texas, Oregon, Ohio, Indiana and Washington and, to a certain extent, on the continued funding of state Medicaid waiver programs. During the three and nine months ended September 30, 1998, direct payments received from state Medicaid agencies accounted for approximately 10.7% of the Company's revenue while the tenant-paid portion of Medicaid residents accounted for approximately 5.8% of the Company's revenue during these periods. The Company expects that state Medicaid reimbursement programs will constitute a significant source of revenue for the Company in the future, furthermore, there can be no assurance the Company's proportionate percentage of revenue received from Medicaid programs will not increase. The revenues and profitability of the Company will be affected by the continuing efforts of governmental and private third-party payors to contain or reduce the costs of health care by attempting to lower reimbursement rates, increasing case management review of services and negotiating reduced contract pricing. In an attempt to reduce the federal and certain state budget deficits, there have been, and management expects that there will continue to be, a number of proposals to limit Medicaid reimbursement in general. Adoption of any such proposals at either the federal or the state level could have a material adverse effect on the Company's business, financial condition, results of operations and prospects. The Company intends to continue developing and operating assisted living residences in other states. Adverse changes in general economic factors affecting these states' respective health care industries or in these states' laws and regulatory environment, including Medicaid reimbursement rates, could have a material adverse effect on the Company's financial condition and results of operations. GOVERNMENT REGULATION. Federal and state governments regulate various aspects of the Company's business. The development and operation of assisted living facilities and the provision of health care Page 18 of 22 services are subject to federal, state and local licensure, certification and inspection laws that regulate, among other matters, the number of licensed beds, the provision of services, equipment, staffing (including professional licensing), operating policies and procedures, fire prevention measures, environmental matters, resident characteristics, physical design and compliance with building and safety codes. Failure to comply with these laws and regulations which in the ordinary course could result in the imposition of fines, restrictions on new resident admissions, the denial of reimbursement, and, in extreme cases, the decertification from the medicare and medicaid program or the revocation of a facility's license or closure of a facility. On October 15, 1998, the Washington Department of Social and Health Services summarily suspended the license of, imposed a stop admissions order on and commenced a license revocation action against a residence located in the state of Washington. On November 5, 1998, the summary suspension of the facility's license was revoked, and the Company continues to contest the stop admissions order and the license revocation action. There can be no assurance that federal, state, or local governments will not impose additional restrictions on the Company's activities that could have a material adverse affect on the Company. State and local laws regulating the Company's operations vary significantly from one jurisdiction to another. In certain states in which the Company is currently developing assisted living facilities, a certificate of need ("CON") or other similar approval may be required for the acquisition or construction of new facilities, the expansion of the number of licensed units or beds or services, or the opening of a home health care agency or hospice. The Company could be adversely affected by the failure or inability to obtain such approval, changes in the standards applicable for such approval and possible delays and expenses associated with obtaining such approval. Federal and state fraud and abuse laws, such as "anti-kickback" laws and "self- referral" laws, govern certain financial arrangements among health care providers and others who may be in a position to refer or recommend patients to such providers. Although the Company has established policies and procedures that it believes are sufficient to ensure that its facilities will operate in substantial compliance with applicable regulatory requirements, there can be no assurance that such fraud and abuse laws will be interpreted in a manner consistent with the practices of the Company. PRICING PRESSURES. The health care services industry is currently experiencing market-driven reforms from forces within and outside the industry that are exerting pressure on health care and related companies to reduce health care costs. These market-driven reforms are resulting in industry-wide consolidation that is expected to increase the downward pressure on health care service providers' margins, as larger buyer and supplier groups exert pricing pressure on health care providers. The ultimate timing or effect of market-driven reforms cannot be predicted. No assurance can be given that any such reforms will not have a material adverse effect on the Company's business, results of operations, financial condition and prospects. HEALTH CARE REFORM. Health care and related services is an area of extensive and dynamic regulatory change. Changes in the law, new interpretations of existing laws, or changes in payment methodology, may have a dramatic effect on the definition of permissible or impermissible activities, the relative costs associated with doing business and the amount of reimbursement by both government and other third-party payors and may be applied retroactively. In addition, to the reforms enacted and considered by Congress from time to time, state legislatures periodically consider various health care reform proposals. Congress and state legislatures can be expected to continue to review and assess alternative health care delivery systems and payment methodologies and public debate of these issues can be expected to continue in the future. The ultimate timing or effect of legislative efforts cannot be predicted and may impact the Company in different ways. There can be no assurances that either the states or the federal government will not impose additional regulations upon the activities of the Company which might adversely affect their businesses, the financial condition, results of operations and prospects. Page 19 of 22 STAFFING AND LABOR COSTS. The Company will compete with other providers of long-term care with respect to attracting and retaining qualified personnel. The Company will also be dependent upon the available labor pool of low-wage employees. A shortage of nurses and/or trained personnel may require the Company to enhance its wage and benefits package in order to compete. No assurance can be given that the Company's labor costs will not increase, or that, if they do increase, they can be matched by corresponding increases in revenues. COMPETITION. The long-term care industry is highly competitive and the Company expects that the assisted living business, in particular, will become more competitive in the future. The Company will be competing with numerous other companies providing similar long-term care alternatives, such as home health agencies, life care at home, community-based service programs, retirement communities and convalescent centers. The Company expects that as assisted living receives increased attention and the number of states which include assisted living in their Medicaid waiver programs increases, competition will grow from new markets entrants, including publicly and privately held companies focusing primarily on assisted living. Nursing facilities that provide long- term care services are also a source of competition to the Company. Moreover, in the implementation of the Company's expansion program, the Company expects to face competition for development and acquisitions of assisted living residences. Some of the Company's present and potential competitors are significantly larger and have, or may obtain, greater financial resources than those of the Company. Consequently, there can be no assurance that the Company will not encounter increased competition in the future which could limit its ability to attract residents or expand its business and could have a material adverse effect on the Company's financial condition, results of operations and prospects. DIFFICULTIES OF MANAGING RAPID GROWTH. The Company expects that the number of residences which it owns, leases or otherwise operates will increase substantially as it pursues its growth strategy. This rapid growth will place significant demands on the Company's management resources. The Company's ability to manage its growth effectively will require it to continue to expand its operational, financial and management information systems and to continue to attract, train, motivate, manage and retain key employees. To the extent such growth is attributable to acquisitions of existing facilities or businesses, the Company's success will depend partly on its ability to integrate effectively such facilities and businesses into the Company's management, information and operating systems. If the Company is unable to manage its growth effectively, its business, financial condition and results of operations could be adversely affected. DEPENDENCE ON SENIOR MANAGEMENT AND SKILLED PERSONNEL. The Company depends, and will continue to depend, upon the services of Mr. McBride, its Chief Executive Officer, Dr. Wilson, its Chief Operating Officer and President, Ms. Marsh, its Vice President/Treasurer and Chief Accounting Officer, Ms. Maloney, its Vice President/Controller, Mrs. Baldwin, its Director of Operations, Ms. Haile, its Vice President/Financial Operations, Ms. Campbell, its Senior Vice President/General Counsel and Ms. Gorshe, its Vice President/Community Relations. The Company has entered into employment agreements with Mr. McBride and Dr. Wilson and all of its executive officers. The Company is also dependent upon its ability to attract and retain management personnel who will be responsible for the day-to-day operations of each residence. The loss of the services of any or all of such officers or the Company's inability to attract additional management personnel in the future could have a material adverse effect on the Company's financial condition or results of operations. LIABILITY AND INSURANCE. The provision of health care services entails an inherent risk of liability. In recent years, participants in the long-term care industry have become subject to an increasing number of lawsuits alleging malpractice or related legal theories, many of which involve large claims and significant Page 20 of 22 defense costs. The Company currently maintains liability insurance intended to cover such claims and the Company believes that its insurance is in keeping with industry standards. There can be no assurance, however, that claims in excess of the Company's insurance coverage or claims not covered by the Company's insurance coverage (e.g., claims for punitive damages) will not arise. A successful claim against the Company not covered by, or in excess of, the Company's insurance coverage could have a material adverse effect upon the Company's financial condition and results of operations. Claims against the Company regardless of their merit or eventual outcome, may also have a material adverse effect upon the Company's ability to attract residents or expand its business and would require management to devote time to matters unrelated to the operation of the Company's business. In addition, the Company's insurance policies must be renewed annually. There can be no assurance that the Company will be able to obtain liability insurance coverage in the future or that, if such coverage is available, it will be available on acceptable terms. ENVIRONMENTAL RISKS. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be held liable for the cost of removal or remediation of certain hazardous or toxic substances, including, without limitation, asbestos- containing materials, that could be located on, in or under such property. Such laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances. The costs of any required remediation or removal of these substances could be substantial and the liability of an owner or operator as to any property is generally not limited under such laws and regulations and could exceed the property's value and the aggregate assets of the owner or operator. The presence of these substances or failure to remediate such substances properly may also adversely affect the owner's ability to sell or rent the property, or to borrow using the property as collateral. Under these laws and regulations, an owner, operator or an entity that arranges for the disposal of hazardous or toxic substances, such as asbestos-containing materials, at a disposal site may also be liable for the costs of any required remediation or removal of the hazardous or toxic substances at the disposal site. In connection with the ownership or operation of its properties, the Company could be liable for these costs, as well as certain other costs, including governmental fines and injuries to persons or properties. As a result, the presence, with or without the Company's knowledge, of hazardous or toxic substances at any property held or operated by the Company, or acquired or operated by the Company in the future, could have an adverse effect on the Company's business, financial condition and results of operations. Environmental audits performed on the Company's properties have not revealed any significant environmental liability that management believes would have a material adverse effect on the Company's business, financial condition or results of operations. No assurance can be given that existing environmental audits with respect to any other Company's properties reveal all environmental liabilities. POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Common Stock could be subject to significant fluctuations in response to various factors and events, including the liquidity of the market for the Common Stock, variations in the Company's operating results, new statutes or regulations or changes in the interpretation of existing statutes or regulations affecting the health care industry generally or assisted living residence businesses in particular. In addition, the stock market in recent years has experienced broad price and volume fluctuations that often have been unrelated to the operating performance of particular companies. These market fluctuation also may adversely affect the market price of the Common Stock. YEAR 2000 COMPLIANCE The Company has assessed its readiness in regard to Year 2000 issues. The Company believes that all material hardware and software utilized in its operations and, specifically, in its accounting systems, is Year 2000 compliant. The Company is in the process of obtaining Year 2000 compliance letters and reports from third party payors, including the federal government. To date, no such payor has indicated an inability to continue remittances in the normal course of business, however, most such payors, including the federal government, are in the process of evaluating and updating their internal systems and cannot yet assure the Company that their systems are year 2000 compliant. The Company also faces the risk that vendors from which the Company purchases goods and services, such as utility providers and the Company's payroll provider, may have systems that are not Year 2000 compliant. The Company plans to monitor the progress of its major vendors in achieving Year 2000 compliance. However, the Company presently does not anticipate the occurrence of major interruption in its business due to Year 2000 issues. Accordingly, the Company does not expect that Year 2000 issues will have a material adverse effect upon the Company's operations or prospects. The Company has not established a contingency plan to address potential Year 2000 noncompliance with respect to the Company's systems or those of its major vendors and is currently considering the extent to which such a plan is necessary. Due to the Company's dependence on systems outside its control, such as telecommunications and power supplies, there can be no assurance that the Company will not face unexpected problems associated with the Year 2000 issue that may affect its operations, business, and financial condition. The Company does not expect to incur any material expense associated with Year 2000 compliance. Page 21 of 22 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 12.1 Computation of Fixed Charge to Earnings 27 Financial Data Schedule (b) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended September 30, 1998. Page 22 of 22 SIGNATURES Pursuant to the requirements of Sections 13 or 15(d) the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ASSISTED LIVING CONCEPTS, INC. Registrant November 16, 1998 By: /s/ RHONDA S. MARSH ------------------------- Name: Rhonda S. Marsh Title: Vice President/Treasurer Chief Accounting Officer EX-12.1 2 COMPUTATION OF FIXED CHARGES EXHIBIT 12.1 RATIO OF EARNINGS TO FIXED CHARGE:
Three Three Nine Nine Months Ended Months Ended Months Ended Months Ended September 30, September 30, September 30, September 30, 1997 1998 1997 1998 ---------------- ------------- -------------- --------------- Income before provision for $1,607 $4,390 $ 3,706 $2,477 income taxes Add fixed charges Interest costs including amortization of debt issuance cost 245 723 653 1,376 ------ ------ ------- ------- Earnings $1,852 $5,113 $ 4,359 $3,853 Fixed charges: Interest expense including amortization of debt issuance costs 245 723 653 1,376 Capitalized interest 1,620 2,540 4,600 6,800 ------ ------ ------- ------- Total fixed charges $1,865 $3,986 $5,253 $8,176 ------ ------ ------- ------- Ratio of earnings to fixed charges - - N/A Excess (deficiency) of earnings to cover fixed charges $ (13) $1,127 $ (894) $(4,323)
EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 9-MOS DEC-31-1998 DEC-31-1998 JUL-01-1998 JAN-01-1998 SEP-30-1998 SEP-30-1998 79,773 79,773 0 0 5,096 5,096 0 0 79 79 92,289 92,289 288,123 288,123 5,741 5,741 400,689 400,689 28,183 28,183 161,250 161,250 0 0 0 0 173 173 145,835 145,835 400,689 400,689 24,162 64,458 24,162 64,458 15,002 39,727 22,157 67,753 0 0 0 0 723 1,376 4,390 2,886 1,668 2,477 2,722 409 0 0 0 0 0 2,770 2,722 (2,361) .16 (.14) .16 (.14)
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