UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________to __________.
Commission file number 0-28656
KARRINGTON HEALTH, INC.
(Exact name of registrant as specified in its charter)
OHIO 31-1461482
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
919 OLD HENDERSON ROAD
COLUMBUS, OH 43220
(614) 451-5151
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Shares, no par value
Indicate by check mark whether the 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 the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: [ ]
Shares of registrant's common shares, no par value, outstanding at March 15,1998
was 6,839,368. As of March 15, 1998, the aggregate market value of the voting
stock held by non-affiliates of the registrant was $51,318,000.
Documents Incorporated By Reference
None
1
PART I
ITEM 1. BUSINESS
GENERAL
In 1989, Richard R. Slager and Alan B. Satterwhite formed DevelopMed
Associates, Inc. for the purpose of developing an assisted living residence
business. In 1991, DevelopMed Associates, Inc. entered into a strategic alliance
with JMAC, Inc., an investment company owned by John H. McConnell and John P.
McConnell, the founder and the chief executive officer, respectively, of
Worthington Industries, Inc. In connection with this alliance, DevelopMed
Associates, Inc. and JMAC Properties, Inc., a wholly owned subsidiary of JMAC,
Inc., formed the Company's predecessor, Karrington Operating Company, an Ohio
general partnership.
Karrington Health, Inc. was incorporated in April 1996 (all references
to the "Company" include Karrington Operating Company and Karrington Health,
Inc.). Initially, 66-2/3% of the Company's common shares were issued to JMAC,
Inc, in exchange for all of its shares of JMAC Properties, Inc. and 33-1/3% of
the Company's common shares were issued to the shareholders of DevelopMed
Associates, Inc. in exchange for all of their shares of DevelopMed Associates,
Inc. As a result, Karrington Operating Company became a subsidiary of the
Company.
The Company's market strategy is to enter middle- to upper-income
markets which have well-established populations of persons 75 years of age and
older and/or persons in the 45-60 years of age caregiver stage. As of December
31, 1998, the Company had developed 50 residences in its target markets, 40 of
which were open and 10 of which were under construction and scheduled to open in
1999 or 2000. These 50 residences are located in Ohio, Pennsylvania, Illinois,
Minnesota, North Dakota, Iowa, Indiana, Colorado, North Carolina, Michigan and
New Mexico. The Company has sites for an additional eight residences under
contract in these states, as well as in Alabama, Mississippi and Texas.
SERVICES AND OPERATIONS
SERVICES PROVIDED. The Company provides assistance to elderly or frail
individuals with limited medical needs and may provide higher levels of personal
assistance for special need residents. Most of the Company's residents have some
disability associated with aging, such as dementia, Alzheimer's disease,
arthritis, nutritional problems, incontinence, strokes or other disorders, and
need assistance with two or more activities of daily living. Residents' needs
generally fall into one or more of the following categories:
- requiring physical support or assistance with activities of daily
living;
- requiring assistance, reminders and cueing due to some cognitive
impairment; and
- requiring socialization and interaction with others.
Residents generally pay a daily suite rental rate under a resident
agreement which is renewable annually and cancelable with 30 days notice. The
daily suite rental rate ranges from $36 to $175 per day, depending on unit size,
location, number of occupants and level of care required. The Company's average
basic daily suite rental rate is approximately $86. The wide range of rates
offered by the Company allows it to accommodate persons of varying financial
resources. Medication administration and various levels of extended care
services, which depend on the degree of frailty, add to the basic care rate.
Additional charges may be incurred for other services such as hair care and
special diets. Currently, approximately 91% of all resident revenues are from
private pay sources.
The Company's basic care program is provided to all residents at no
additional cost. This basic care program includes:
2
- - limited assistance with daily living;
- - three meals per day served in a common dining room;
- - 24-hour security;
- - emergency call systems in each unit and living area;
- - assistance with arranging outside services such as physician care, various
therapy programs and other medical services;
- - personal laundry services;
- - housekeeping services; and
- - social and recreational activities.
In addition to the basic care program, non-Alzheimer's residents may be
included in the extended care program, which assists residents who require more
frequent or more intensive assistance or care. Prior to entering a residence,
and periodically during their stay, individuals' needs are assessed to determine
the level of extended care services required, and an individual care plan is
designed. The Company's experience is that most of its non-Alzheimer's residents
require some extended care services or require medication administration at an
average cost of $15 per day.
The Company's Alzheimer's and other cognitive disorder programs are
provided in each prototype residence on a designated "special care" floor or
wing. The Company also develops residences designed specifically for Alzheimer's
disease care. Trained staff provide special care programs for cognitively
impaired residents, and each is charged additional daily fees for this added
support. Programs include added assistance, stimulation, special activities,
intervention and therapeutic programs that are developed and supported by
physicians specializing in dementia care that consult with the Company.
STAFFING. Each residence, excluding cottages, has an administrator and
a seven-person management team. The resident care coordinator supervises all
resident support staff and care plans. A registered nurse/wellness director is
responsible for all wellness programs, as well as medication and other ancillary
support programs. The director of administration is responsible for general
administrative duties. The marketing director, activities director, chef and
environmental services director complete the management team. Each cottage model
has an administrator, an associate administrator and a wellness director.
Residence management teams report to a regional director responsible for the
operation of several residences. Regional directors provide support, oversight
and mentoring to each residence's staff.
Staffing models are used to determine appropriate personnel levels.
Screening is used to help select staff with "care providing" characteristics.
For each residence, regardless of size, services are provided on a 24 hour per
day basis with an overall average 1:12 staff to resident ratio. The staffing
ratio for dementia care is 1:7 at all times. The average daytime staffing ratio
for all residences is 1:9. The largest percentage of care staff includes trained
staff members who are responsible for providing support and care to residents
and licensed nurses who coordinate care assessments and implement treatment and
therapies.
The Company maintains competitive compensation programs, including
incentives and quarterly profit sharing, which it believes help attract and
retain excellent employees. The Company believes that the combination of proper
interviewing, selection methods and review, training and appropriate incentives
significantly reduces hiring and retraining costs and allows for a more stable,
long-term work force. All management team members participate in a recruitment
and development program called the Predictive Index(R). The Predictive Index(R)
is a third-party program to determine key criteria and personal attributes that
the Company believes are important to the proper placement of staff and
management.
3
TRAINING AND QUALITY ASSURANCE. The Company provides its personnel with
an extensive and innovative training program. Before contact with residents, an
employee must complete a 40 hour curriculum covering all aspects of the
Company's operation, from housekeeping schedules to coping with death and dying.
New employees are then paired with a mentor who supervises his or her work until
the supervisor has certified that the employee has completed all aspects of the
training program. This certification process generally takes about a week. Each
new employee is reviewed for performance at the end of a 90-day probationary
period. The Company provides continuing education for all employees to enhance
the quality of care provided to residents.
The Company has structured a comprehensive quality assurance program
intended to maintain standards of care established for each residence. Under the
Company's quality assurance program, the care and services provided at each
residence are monitored by the professional services staff which reports
directly to senior management. The quality assurance team works with residence
management teams to assure that all staff members are trained, that operational
policies and procedures are followed, and that all state and federal standards
are met while achieving the stringent requirements of the Company. The Company's
quality assurance program helps support compliance with federal and state
regulations and requirements for licensing. The Company has also developed a
quality of service program which includes periodic surveys and follow-up with
all current and former residents and responsible parties.
ARCHITECTURAL DESIGNS
Recognizing that not all seniors share the same acuity at various
income levels, the Company has created three standard models of residence, an
evolution of the Company's original prototype mansion-style residence. Along
with creating three standard models, the Company has branded, or named, its
residential products to help build the Company's national identity.
Karrington's original mansion-style residence, now known as K1 or the
Karrington model, is a freestanding, mansion-style building in any of a variety
of exterior styles. Located in established upper-income communities, the K1
replaces the original 53-unit prototype. The K1 prototype averages 72 units and
approximately 50,000 square feet and is generally built on a 2.5 to 4 acre site.
The Company's one-story model, K2, is a small-town solution to
high-quality assisted living. The K2 model residence averages 48 units with a
designed capacity of 61 residents. The K2 offers residents of smaller and rural
communities access to the skilled and caring professionals, unique products and
services, and dignified environments that enable residents to age-in-place
gracefully.
A typical resident unit consists of a bedroom, bathroom with shower,
lavatory and toilet, vestibule with kitchenette and closet. A variety of unit
sizes and configurations allows resident choice in accommodations. Unit size
ranges from approximately 250 square feet to over 450 square feet and there are
both single room units and two room units. Units are marketed for single
occupancy, companion occupancy with two residents sharing the same bedroom, and
doubles and suites containing a living room and a bedroom.
Approximately 45-50% of each of the K-1 and K-2 models is devoted to
common areas and amenities. The interior design promotes a home-like environment
while permitting the effective provision of resident care programs and promoting
resident independence. The individual resident suites are clustered on each
floor to resemble a neighborhood, with a variety of suite floor plans of one or
two rooms and varying square footage. Each floor has a quiet area resembling a
library or den and an active area designed to support activity programs and
interaction among residents, staff and families. The main floor usually includes
the main dining room, private dining rooms, administrative offices, a library, a
living or family room, and ice cream parlor and a year-round sun porch. Also
included are public restrooms, outside porches, a foyer and a formal entryway
with grand staircase and central elevator. On other floors in each residence are
located a resident laundry room, a wellness center, a bathing spa area, employee
break rooms, a beauty salon and activity areas. The special care floor also
includes a separate resident kitchen and dining area.
The Company's third residential model is the outgrowth of the May 1997
acquisition of Kensington Management Group, Inc. of Golden Valley, Minnesota.
Operating innovative
4
Alzheimer's care communities, now known as Karrington Cottages or KC, the
Company provides residential Alzheimer's care and other programs under the
medical direction of geriatric and dementia specialists. The Karrington Cottage
prototype model is 20 units with 36 beds.
The Company believes all three basic building plan designs provide it
with flexibility in adapting the model to a particular site and local zoning
requirements.
DEVELOPMENT
The Company's development personnel research and identify potential
markets, primarily in major metropolitan areas and their surrounding suburban
communities, and select sites for development within such markets. In evaluating
a market, the Company considers a number of factors, including:
- population, income and age demographics;
- traffic count;
- site visibility;
- residential and commercial characteristics;
- probability of obtaining zoning approvals;
- proximity of various competitors;
- estimated market demand; and
- the potential to achieve economies of scale in a specific market by
concentration of its development and operating activities.
The principal stages in the development process are (a) strategic
market selection and assessment, (b) site selection and contract signing, (c)
zoning and site plan approval, (d) architectural planning and design, (e)
contractor selection and (f) construction and licensure. Once a market has been
identified, site selection and contract signing typically take three months.
Zoning and site plan approval generally take three to nine months and are
typically the most difficult step in the development process as a result of the
Company's selection of sites in established communities which frequently require
site rezoning. Architectural planning and design and contractor selection often
occur during the zoning process but can prolong the start of construction.
Residence construction generally takes 12 months. After a residence receives a
certificate of occupancy and appropriate licenses, residents usually begin to
move in immediately. The Company's experience indicates that new residences
typically reach a stable level of occupancy of over 90% within 13 months, but
there can be no assurance that these results will be achieved in new markets.
The Company estimates that total capitalized cost to develop, construct and open
a K-1 or K-2 model residence, including land acquisition and construction costs,
ranges from approximately $5.0 million to $11.0 million, an average cost per
unit of approximately $110,000. The cost of any particular residence may vary
considerably based on a variety of site-specific factors.
MARKETING
The Company's marketing approach emphasizes consumer education and
awareness directed to potential residents and family members. The adult children
of residents tend to be significant decision-makers in the selection of the
assisted living option. Other significant referral sources include:
- hospital discharge planners;
- physicians;
5
- churches;
- social service agencies focused on the elderly;
- nursing facilities in the area;
- home health agencies;
- social workers;
- legal advisors;
- - other health care providers; and
- - families of existing residents.
Telephone directory advertising, media products and informal "networking" are
directed by the Company toward educating decision-makers and other referral
sources in a community. The marketing personnel in the Company's corporate
office develop the overall strategy in each market as well as media materials,
databases, direct mail, signage and community outreach activities. Each
residence has a marketing director responsible for generating and following-up
leads, coordinating referral activities and providing tours, counseling and
caregiving advice for potential residents and their families with respect to the
Company's residences and services.
Marketing activities begin during the development stage of a residence,
after the Company has obtained site control. These activities continue with
increased emphasis when an information center opens for a specific residence
approximately six to nine months prior to opening.
REGULATION
The Company's assisted living residences are subject to regulation and
licensing by state and local health and social service agencies and other
regulatory authorities. Requirements vary from state to state.
These requirements address:
- personnel education, training and records;
- facility services, including administration of medication and the
provision of limited nursing services;
- physical plant specifications;
- furnishing of residents' units;
- food and housekeeping services;
- emergency evacuation plans; and
- residents' rights and responsibilities.
Assisted living residences also are subject to state or local fire and building
codes and food service licensure requirements. Like other health care
residences, assisted living residences are subject to periodic survey or
inspection by governmental authorities. From time to time in the ordinary course
of business, the Company receives survey reports. The Company reviews such
reports and takes appropriate corrective action if deficiencies are noted.
Inspection deficiencies are resolved through a plan of correction, although the
reviewing agency typically is authorized to take action against a licensed
facility where deficiencies are noted in the survey process. Such action may
include imposition of fines, imposition of a provisional or conditional license
or suspension or revocation of a license or other sanctions.
6
Health care is an area of extensive and frequent regulatory change. The
assisted living model for long-term care is relatively new. Accordingly, the
manner and extent to which it is regulated at the federal and state levels is
evolving. Changes in the laws or new interpretations of existing laws may have a
significant effect on methods and costs of doing business. The Company is
actively involved in monitoring regulatory and legislative changes affecting the
assisted living industry and participates with industry organizations to
encourage improvements to existing laws and regulations.
The success of the Company will depend in part upon its ability to
satisfy applicable regulations and requirements and to procure and maintain
required licenses as the regulatory environment for assisted living evolves. The
Company's operations also could be adversely affected by future regulatory
developments such as mandatory increases in the scope and quality of care to be
offered to residents and revisions to licensing and certification standards.
The Company currently is not a Medicare provider. Under some state
licensure laws, and for the convenience of its residents, some of the Company's
assisted living residences maintain contracts with several health care providers
and practitioners through which health care providers make their health care
products or services available to residents. These contract parties include
pharmacies, visiting nurses, social service and home health organizations. Some
of the services furnished by these contract parties may be covered by the
Medicare programs.
COMPETITION
The Company's competition comes from a variety of sources. As a
provider of care and services to elderly or frail individuals, the Company
competes with companies such as home health care agencies, retirement
communities, skilled nursing facilities and convalescent centers, as well as
other assisted living facilities. In each of these cases, however, the Company's
ability to provide a non-institutional environment for persons who need higher
levels of care enhances its competitive strength.
The assisted living industry is highly fragmented. Although some
competitors are significantly larger, there are no one or more dominant
companies in the assisted living segment. In a recent industry report, it is
estimated that there are approximately 770,000 total assisted living beds
currently available, and that the 25 largest owners of assisted living
properties has 180,446 or only 23% of those currently available. The largest
individual owner has only 3% of the total assisted living beds currently
available.
Because little public funding exists for assisted living, most
residents are private pay. Within the assisted living industry, providers
compete by price, quality of care, service packages and quality of life. The
Company believes that its combination of buildings, furnishings, care, services
and other amenities enables it to compete effectively.
PROPRIETARY INFORMATION
The Company is the registered owner of the service mark "Karrington
Communities(R)." The Company believes this mark is of material importance to its
business.
EMPLOYEES
As of March 1, 1999, the Company had approximately 1,800 employees,
including approximately 350 employed by the Company's joint ventures. None of
the Company's employees are represented by a union or covered by a collective
bargaining agreement. The Company has experienced no work stoppages and
considers its relationship with its employees to be good.
7
ITEM 2. PROPERTIES
The following three tables set forth as of December 31, 1998 specified
information as to the Company properties which are open, under construction or
in development, respectively, including whether such properties are wholly-owned
("O"), jointly-owned ("J"), leased ("L") or majority-owned ("M"). With respect
to properties which are not wholly-owned, information as to the percentage of
the Company's ownership is set forth in the footnotes to the table. With respect
to properties in development, the stage of development, whether in zoning ("I")
or zoned ("Z"), is also included:
OPEN RESIDENCES
TYPE OF METRO OPENED OR NUMBER NUMBER OF
OWNERSHIP LOCATION ACQUIRED OF UNITS BEDS
- ------------------------------------------------------------------------------------------------------------------------
Karrington of Bexley L (1) Columbus, OH 10/92 53 62
Karrington on the Scioto L (1) Columbus, OH 3/93 53 63
Karrington at Tucker Creek L (1) Columbus, OH 12/93 54 62
Karrington of Oakwood J (3) Dayton, OH 11/94 53 62
Karrington of Shaker Heights O Cleveland, OH 10/95 59 67
Karrington Place L (1) Columbus, OH 2/96 26 31
Karrington of South Hills O Pittsburgh, PA 8/96 67 81
Karrington of Albuquerque J (3) Albuquerque, NM 10/96 61 74
St. Francis Place J (3) Albuquerque, NM 10/96 28 32
Karrington at Fall Creek O Indianapolis, IN 3/97 61 71
Karrington Commons of Buffalo O Buffalo, MN 5/97 70 75
Karrington Commons of Bismarck O Bismarck, ND 5/97 66 81
Karrington Cottages of Bismarck O Bismarck, ND 5/97 12 20
Karrington Cottages of Waterloo O Waterloo, IA 5/97 12 20
Karrington Cottages of Mankato O Mankato, MN 5/97 12 20
Karrington Cottages of Rochester I O Rochester, MN 5/97 12 20
Karrington Cottages of Rochester II O Rochester, MN 5/97 12 20
Karrington Cottages of Rochester III O Rochester, MN 5/97 16 28
Karrington Cottages of Rochester IV O Rochester, MN 8/97 16 28
Karrington of Kenwood J (3) Cincinnati, OH 6/97 67 77
Karrington Cottages of Buffalo I O Buffalo, MN 7/97 12 20
Karrington Cottages of Buffalo II O Buffalo, MN 7/97 12 20
Karrington of Willow Lake O Indianapolis, IN 8/97 61 72
Karrington of Fort Wayne O Fort Wayne, IN 8/97 61 72
Karrington of Englewood J (3) Dayton, OH 9/97 48 61
Karrington of Colorado Springs J (3) Colorado Springs, CO 12/97 64 71
Karrington of Findlay J (4) Findlay, OH 12/97 48 61
Karrington of Fremont O Fremont, OH 2/98 48 61
Karrington of Wooster O Wooster, OH 2/98 48 61
Karrington of Bath L (2) Akron, OH 2/98 67 75
Karrington of Gahanna L (2) Columbus, OH 2/98 50 54
Karrington of Carmel L (2) Indianapolis, IN 3/98 57 72
Karrington Cottages of Rochester V O Rochester, MN 5/98 20 36
Karrington of Rocky River L (1) Cleveland, OH 4/98 64 72
Karrington of South Charlotte O Charlotte, NC 6/98 72 84
Karrington of Presque Isle Bay L (1) Erie, PA 6/98 69 80
Karrington of Ann Arbor L (2) Ann Arbor, MI 8/98 67 75
Karrington of Poland L (2) Youngstown, OH 8/98 67 75
Karrington of Park Ridge M (5) Chicago, IL 10/98 111 132
Karrington of Monroeville O Pittsburgh, PA 11/98 64 72
- ------------------------------------------------------------------------------------------------------------------------
TOTAL 1,920 2,320
- ------------------------------------------------------------------------------------------------------------------------
8
RESIDENCES UNDER CONSTRUCTION
TYPE OF METRO PLANNED NUMBER NUMBER OF
OWNERSHIP LOCATION OPENING OF UNITS BEDS
------------------------------------------------------------------------------------------------------------------------
Karrington of Eastover L (2) Charlotte, NC 1/99 88 100
Karrington at the Shawhan O Tiffin, OH 3/99 54 66
Karrington Cottages of Rochester VI O Rochester, MN 7/99 20 36
Karrington Cottages of Rochester VII O Rochester, MN 7/99 20 36
Karrington Cottages of Rochester VIII O Rochester, MN 7/99 20 36
Karrington Cottages of Rochester IX O Rochester, MN 7/99 15 27
Karrington of Hamilton O Hamilton, OH 10/99 48 60
Karrington of Farmington Hills O Detroit, MI 10/99 72 83
Karrington of Edina O Minneapolis, MN 12/99 93 105
Karrington of Finneytown J (3) Cincinnati, OH 1/00 67 75
- ------------------------------------------------------------------------------------------------------------------------
TOTAL 497 624
- ------------------------------------------------------------------------------------------------------------------------
SITES UNDER CONTRACT
STAGE OF METRO PLANNED PLANNED PLANNED
DEVELOPMENT LOCATION OPENING UNITS BEDS
-----------------------------------------------------------------------------------------------------------------------
Karrington at the Highlands Z Mobile, AL 1Q, 2000 68 77
Karrington of Northpointe Z Jackson, MS 1Q, 2000 68 77
Karrington of Northwood Z Dallas, TX 1Q, 2000 68 78
Karrington of Pleasant Valley Z Cleveland, OH 2Q, 2000 72 82
Karrington of Millcreek I Erie, PA 2Q, 2000 60 108
Karrington of Naperville Z Chicago, IL 2Q, 2000 93 105
Karrington of Mansfield I Mansfield, OH 2Q, 2000 50 60
Karrington of Cuyahoga Falls Z Akron, OH 2Q, 2000 72 83
- ------------------------------------------------------------------------------------------------------------------------
TOTAL 551 670
- ------------------------------------------------------------------------------------------------------------------------
- ---------------
(1) These residences are leased under a triple net, 20-year master lease
agreement, which is more fully described in Note 5 of Notes to
Consolidated Financial Statements.
(2) Represent operating leases with Sunrise Midwest Leasing, LLC, which
are described in Note 6 of Notes to Consolidated Financial Statements.
(3) The Company has entered into joint development relationships with
Catholic Health Initiatives, a large, not-for-profit health
organization that operates 70 hospitals and more than 50 long-term care
facilities in 22 states and has annual combined revenues of $4.7
billion. The Company and CHI have entered into joint venture agreements
to develop, operate and own seven assisted living residences, six of
which were open and one of which was under construction at December 31,
1998. The Company owns:
- 19.9% of Karrington of Albuquerque, St. Francis Place, Karrington
of Colorado Springs Karrington of Englewood;
- 35% of Karrington of Finneytown and Karrington of Kenwood; and
- 50% of Karrington of Oakwood.
The Company operates each residence in accordance with a 20-year
management agreement that generally provides compensation at 5% of net
resident revenues.
See Note 7 of Notes to Consolidated Financial Statements.
(4) Represents a 50-50 joint venture with a local hospital in Findlay,
Ohio, which is described in Note 7 of Notes to Consolidated Financial
Statements. The Company operates this residence under a 20-year
management agreement that provides compensation at 6% of net resident
revenues.
9
(5) The Company owns a 70% controlling interest in Karrington of Park
Ridge, which it developed, constructed and manages.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in litigation pending in the
Franklin County Court of Common Pleas, Columbus, Ohio. On May 29, 1998, Lou
Buren, formerly Vice President-Marketing of the Company, filed suit against
the Company for wrongful termination of employment. The original suit sought
damages of approximately $450,000. On March 3, 1999, Mr. Buren filed an
amended complaint joining Karrington Operating Company, a subsidiary of the
Company, and two Company officers as defendants and increasing the amount of
damages sought to approximately $6.7 million. The Company denies Mr. Buren's
claims and intends to vigorously defend itself.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matter to a vote of its security holders
during the fourth quarter of its fiscal year ended December 31, 1998.
PART II
ITEM 5(A). MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's common shares are quoted on the National Market tier of
the Nasdaq Stock Market under the symbol "KARR." The following table sets forth
the high and low reported sales prices of the Company's common shares for the
periods indicated.
HIGH LOW
---- ---
1999 QUARTER ENDED
March 31, 1999 (through March 15, 1999)...................... $16.00 $ 8.75
1998 QUARTER ENDED
December 31, 1998............................................ 16.63 7.50
September 30, 1998 .......................................... 10.00 6.00
June 30, 1998 ............................................... 12.75 9.00
March 31, 1998 .............................................. 13.75 10.75
1997 QUARTER ENDED
December 31, 1997 ........................................... 14.50 10.50
September 30, 1997 .......................................... 16.50 10.75
June 30, 1997 ............................................... 16.00 10.00
March 31, 1997 .............................................. 13.00 10.50
The Company had 110 shareholders of record as of March 15, 1999. The
Company believes a substantially larger number of beneficial owners hold such
shares in depository or nominee form.
The Company has never paid dividends on its common shares.
(B). Not applicable.
10
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data and
other operating data of the Company. The selected consolidated financial data
for each of the five years in the period ended December 31, 1998 have been
derived from the audited consolidated financial statements of the Company. This
data should be read in conjunction with the more detailed information contained
in the Consolidated Financial Statements and accompanying Notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Form 10K.
-------------------------------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
Residence operations............................... $ 33,883 $ 18,539 $8,953 $ 6,220 $ 4,977
Development and project management fees............ 942 681 643 524 287
--------- --------- -------- -------- --------
Total......................................... 34,825 19,220 9,596 6,744 5,264
Expenses:
Residence operations............................... 28,289 13,683 6,486 4,335 3,409
General and administrative......................... 6,465 4,433 2,773 1,705 634
Depreciation and amortization...................... 5,232 2,684 1,379 980 844
Rent expense....................................... 3,993 259 89 45 45
Unusual charges.................................... - 1,380 - 492 -
--------- --------- -------- -------- -------
Total......................................... 43,979 22,439 10,727 7,557 4,932
--------- --------- -------- -------- --------
Operating income (loss)................................ (9,154) (3,219) (1,131) (813) 332
Interest expense....................................... (5,882) (2,743) (1,272) (1,023) (1,350)
Interest income........................................ 338 349 470 - -
Equity in net loss of unconsolidated entities.......... (632) (247) (7) (105) (17)
Minority interest of consolidated entity .............. 194 - - - -
--------- --------- -------- -------- --------
Loss before income taxes............................... (15,136) (5,860) (1,940) (1,941) (1,035)
Income tax benefit (provision)........................ (340) 190 (683) - -
--------- --------- -------- -------- --------
Net loss $(15,476) $ (5,670) $(2,623) $(1,941) $(1,035)
--------- --------- -------- -------- --------
--------- --------- -------- -------- --------
Net loss per common share - basic and diluted ........ $ (2.26) $ (.83)
Weighted average number of common shares outstanding.. 6,838 6,792
AS OF DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(IN THOUSANDS)
--------------
BALANCE SHEET DATA:
Working capital (deficit).............................. $(13,437) $ (6,694) $ 7,806 $(1,575) $ (911)
Total assets........................................... 141,172 141,316 69,550 26,676 16,292
Long-term debt, less current portion................... 95,753 97,067 32,759 18,250 16,778
Shareholders' equity (deficit)......................... 11,047 26,507 30,677 5,841 (1,763)
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
OTHER DATA:
Residences (end of period) (1):
Open.............................................. 40 27 9 5 4
Under construction................................ 10 19 17 5 1
Under contract.................................... 8 20 10 8 2
Number of units (end of period) (1):
Open.............................................. 1,920 1,124 454 272 213
Under construction................................ 497 1,019 1,010 243 59
Under contract.................................... 551 1,390 742 509 128
11
(1) Includes wholly owned, jointly owned and leased residences. See
"Properties" for additional information regarding the Company's forms of
ownership of its residences.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is an operator and owner of licensed, assisted living
residences which provide quality, professional, personal and health-care
services, including an emphasis on Alzheimer's care, for individuals needing
assistance with activities of daily living. These activities include bathing,
dressing, meal preparation, housekeeping, taking medications, transportation,
and other activities that, because of the residents' conditions, are difficult
for residents to accomplish in an independent living setting. The Company offers
its customers a dignified residential environment focused on quality of life.
The Company also provides development, support and management services to its
joint venture residences. As of December 31, 1998, the Company had 40
residences, including joint ventures, open in 11 states with a capacity of 2,320
residents. Six additional residences were under construction while four others
were complete and being readied for occupancy.
These ten residences have a capacity of 624 residents.
The Company derives its revenues primarily from: (a) resident fees for
the delivery of basic assisted living care services, which accounted for 80% of
total revenues in 1998; (b) resident fees for extended and special needs care
services which accounted for 9% of total revenues in 1998; and (c) community fee
revenue which accounted for 8% of total revenues in 1998. Resident fees include
revenue derived from basic assisted living care, community fees, extended and
special needs care and other sources. Community fees are one-time fees generally
payable by a resident upon admission. Extended and special needs care are paid
by residents who require personal care in excess of services provided under the
basic care program.
The following table sets forth specified information regarding the
Company's residences as of December 31, 1998:
----------------------------- ----------------------------- -----------------------------
COMPANY RESIDENCES JOINTLY-OWNED RESIDENCES TOTAL SYSTEM
----------------------------- ----------------------------- -----------------------------
RESIDENCES UNITS BEDS RESIDENCES UNITS BEDS RESIDENCES UNITS BEDS
----------------------------- ----------------------------- -----------------------------
Open 33 1,551 1,882 7 369 438 40 1,920 2,320
Under construction 9 430 549 1 67 75 10 497 624
In development:
Under contract and
zoned 6 441 502 - - - 6 441 502
Under contract and
in zoning 2 110 168 - - - 2 110 168
RESULTS OF OPERATIONS
The following significantly impacts results of operations:
OCCUPANCY OF RESIDENCES IN OPERATION
The Company classifies residences that have been open at least 12
months or have achieved an occupancy percentage of 95% or above to be stabilized
residences. The Company's ability to maintain a high occupancy percentage in
stabilized residences has a significant impact on results of operations. This is
because many costs are fixed and a decline in occupancy below approximately
70-75% means that the residence is not contributing net profits to the Company's
results of operations.
12
RESIDENCES IN THE FILL-UP PHASE
The number of residences moving from the construction to the fill-up
phase can have a significant impact on operations. It typically takes 13 months
for a new residence to reach an occupancy level of 90%. During that time, the
residence is incurring significant losses because of fixed occupancy costs and
payroll. Fixed occupancy costs include interest, depreciation, rent and real
estate taxes. The speed at which a residence can achieve stabilization can have
a significant effect on operations. In periods where the percentage of
residences in the fill-up phase is significant, as is the case for 1998,
operating losses will be significant and will continue until the Company reaches
a base of stable homes that absorb losses generated by residences in the fill-up
phase. Based on past experience, we expect that all residences currently in the
fill-up phase will reach stabilization in late 1999. Summarized below is a
breakdown of open consolidated stable residences and open consolidated
residences in the fill-up phase for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------ -- ------------------ -- -------------------
1998 1997 1996
------------------ ------------------ -------------------
Stable residences........ 15 13 3
Residences in fill-up.... 18 7 3
------------------ ------------------ -------------------
Total.................... 33 20 6
------------------ ------------------ -------------------
------------------ ------------------ -------------------
Percent in fill-up....... 55% 35% 50%
------------------ ------------------ -------------------
------------------ ------------------ -------------------
GENERAL AND ADMINISTRATIVE COST
The Company requires a particular level of general and administrative
spending to operate. General and administrative spending has increased
significantly over the past three years as the Company has incurred costs to
support the growth of its business. However, this spending is not variable in
that it does not increase proportionately with the number of residences in
operation. Consequently, as the Company grows, general and administrative costs
as a percent of revenues should decrease.
LEASE VS. MORTGAGE FINANCING
The Company initially followed a plan of ownership using mortgage
financing. This approach results in depreciation and interest charges that tend
to be highest in the early years of operation. During 1998, the Company opened
five residences under operating leases. The Company has also entered into
sale/leaseback transactions in 1998 on six additional residences that were
originally owned and financed under mortgages. Lease financing is advantageous
from a results of operations perspective because rent expense under operating
leases is lower than depreciation and interest under traditional ownership and
mortgage arrangements.
RESIDENCES UNDER CONSTRUCTION
The number of residences under construction impacts the results of
operations due to the impact on capitalization of internal development and
construction department costs, as well as interest, that are capitalized as part
of construction. Fewer residences under development or construction mean less
cost is capitalized, which adversely impacts the results of operations.
UNUSUAL CHARGES
The 1997 charge was primarily due to the Company's decision to abandon
some of its projects in development.
13
The following table sets forth specified data from the respective
consolidated statements of operations as a percentage of total revenues:
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996
--------------- -------------- --------------
Total revenues................................ 100.0% 100.0% 100.0%
Expenses:
Residence operations..................... 81.2 71.2 67.6
General and administrative............... 18.6 23.1 28.9
Depreciation and amortization............ 15.0 14.0 14.4
Rent expense............................. 11.5 1.3 0.9
Unusual charges.......................... -- 7.2 --
--------------- -------------- --------------
Total expenses....................... 126.3 116.8 111.8
--------------- -------------- --------------
Operating income (loss)....................... (26.3)% (16.8)% (11.8)%
--------------- -------------- --------------
--------------- -------------- --------------
End of period (1):
Number of residences..................... 33 21 6
Number of units.......................... 1,551 803 312
- --------------
(1) Excludes residences jointly-owned by the Company accounted for by the
equity method.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Total revenue increased $15.6 million, or 81%, to $34.8 million in 1998
from $19.2 million in 1997 primarily due to the opening of new residences ($8.0
million), the acquisition of Kensington Management Group, Inc. and affiliates on
April 30, 1997 ($3.8 million) and the increased occupancy of residences in the
fill-up phase in 1997. Average occupancy for the stabilized residences in 1998
and 1997 was 89%.
Residence operating expenses increased $14.6 million, or 107%, to $28.3
million in 1998 from $13.7 million in 1997. As a percentage of residence
operating revenues, residence operating expenses increased from 74% in 1997 to
83% in 1998 which resulted in a residence net operating income margin of 26% in
1997 and 17% in 1998. The decrease in net operating income resulted from
start-up losses associated with residences open less than one year (18
residences in 1998 vs. 7 residences in 1997).
General and administrative expenses increased $2.1 million, or 46%, to
$6.5 million in 1998 from $4.4 million in 1997 primarily due to the acquisition
of Kensington ($.2 million), a provision for terminated projects of $.9 million
largely due to the abandonment of one site and the third quarter sale of two
additional sites and an increase in uncapitalized construction and development
costs of $.8 million. The Company expects general and administrative expenses
will continue to decrease as a percentage of total revenues due to anticipated
economies of scale resulting from an increase in the number of open residences.
Rent expense increased $3.7 million to $4.0 million in 1998 due to the
opening of five leased residences in 1998 and the sale of six residences in
sale-leaseback transactions in the second quarter of 1998.
Depreciation and amortization increased $2.5 million, or 95%, to $5.2
million in 1998 from $2.7 million in 1997 primarily due to the opening of new
residences ($2.4 million), residences open for only a partial period in 1997
($.3 million) and the acquisition of Kensington ($.3 million), offset by lower
depreciation and amortization resulting from the sale of six residences in
sale-leaseback transactions in the second quarter of 1998.
Interest expense increased $3.2 million, or 114%, to $5.9 million in
1998 from $2.7 million in 1997 primarily due to the opening of new residences
and residences open for only a partial period in
14
1997 ($1.9 million), the acquisition of Kensington ($.9 million), a decrease in
capitalized interest ($.8 million) and the increased use of lines of credit ($.5
million), offset by lower interest expense resulting from residences sold in
sale-leaseback transactions in the second quarter of 1998.
The equity in net loss of unconsolidated entities increased due to four
joint venture residences in the fill-up phase during 1998 compared to two joint
venture residences in the fill-up phase during 1997. See Note 2 to Consolidated
Financial Statements for discussion on the minority interest of consolidated
entity.
The tax provision recorded in 1998 represents a current state tax
liability resulting from tax gains primarily associated with sale/leaseback
transactions. No deferred tax benefit was recorded in 1998 due to limitations
associated with the recognition of operating loss carryforwards and other tax
assets.
The net loss for 1998 compared to the net loss for 1997 increased
substantially from $5.7 million to $15.5 million. The increase in the net loss
is primarily attributable to the significant increase in the number of
residences in the fill-up phase and increased general and administrative costs
necessary to support the Company's growth. The increase in net loss of $9.8
million is attributable primarily to residences opened in 1998 and the
Kensington acquisition, which generated combined incremental losses of more than
$8.3 million, and the increase in general and administrative costs of $2.1
million.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenue increased $9.6 million, or 100%, to $19.2 million in 1997
from $9.6 million in 1996 primarily due to the growth in resident revenues.
Resident revenues increased $9.6 million, or 107%, primarily due to the
acquisition of Kensington on April 30, 1997 ($5.2 million), opening of new
residences in 1997 ($1.3 million) and a full year of operations of residences
opened or in fill-up in 1996.
Residence operations expense increased $7.2 million, or 111%, to $13.7
million in 1997 from $6.5 million in 1996. As a percentage of residence
operating revenues, residence operations expense increased to 73.8% in 1997 from
72.4% in 1996. This increase is primarily attributable to an increase in the
number of residences in the fill-up phase as operations expenses are
historically higher as a percent of operating revenues during the first year of
operation of a residence.
General and administrative expenses increased $1.6 million, or 59.9%,
to $4.4 million in 1997 from $2.8 million in 1996, primarily due to increased
compensation, payroll taxes and related benefits as a result of hiring
additional management and staff at the Company's headquarters as a result of the
Company's growth plans. The Company expects the rate of increase in its general
and administrative expenses will decrease as new personnel needs have been
reduced by recent hires. In addition, the Company expects its general and
administrative expenses will decrease as a percentage of its total operating
revenues due to anticipated economies of scale resulting from the Company's
development program.
Depreciation and amortization increased $1.3 million, or 94.6%, to $2.7
million in 1997 from $1.4 million in 1996 primarily due to the opening of new
residences in 1997 and 1996.
See Note 2 to Consolidated Financial Statements for discussion on the
unusual charges in 1997.
Interest expense increased $1.4 million, or 116%, to $2.7 million in
1997 from $1.3 million in 1996 primarily due to the opening of new residences in
1997 and 1996.
The net loss for 1997 compared to the net loss for 1996 increased
substantially from $2.6 million to $5.7 million. The increase in the net loss is
primarily attributable to the significant increase in the number of residences
in the fill-up phase and increased general and administrative costs necessary to
support the Company's growth. The increase in net losses of $3.0 million is
attributable primarily to residences opened or acquired in 1997, which generated
losses of
15
approximately $2.5 million for 1997, and the increase in general and
administrative costs of $1.7 million. These losses were offset by increased net
profits of residences in the fill-up phase in 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its initial growth through a combination of
mortgage financing, sale/leasebacks, a development bond, subordinated borrowings
from JMAC, bank lines-of-credit, equity contributions and proceeds from the
initial public offering in 1996. The Company's mortgage and construction
mortgage financings mature in the next one to thirteen years, bear interest at
various fixed and fluctuating rates and are secured by substantially all of the
assets of the Company. The Company expects to refinance such amounts as they
mature.
Net cash used in operations has increased from $.9 million in 1996 to
$7.7 million in 1998. This continued increase reflects the operating losses
associated with newly opened residences and increased general and administrative
costs as part of the Company's rapid growth plan over this period. As discussed
previously, residences in the fill-up phase generate operating losses until
reaching 70-75% occupancy. The Company's mix of residences in the fill-up phase
has increased and represent 55% of all open residences in 1998. Cash used by
operations will continue in the near future until such time as residences
currently in the fill-up phase become stable and generate enough net profits to
absorb losses from start-up residences.
Net cash used in investing activities totaled $1.9 million, $53.6
million and $27.7 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Excluding cash generated from sale and sale/leaseback transactions
of $41.6 million, cash used by investing activities totaled $43.6 million in
1998. These expenditures related primarily to the Company's construction and
development activities.
Net cash provided by financing activities totaled $8.0, $49.6 million
and $40.8 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Cash provided from financing activities from 1996 through 1998
included $90.7 million from mortgages, $10.3 million from lines of credit, $7.5
million from JMAC and $27.5 million related to the Company's initial public
offering in 1996. During the same period, the Company repaid approximately $36.2
million of mortgages. Net cash provided by financing activities was used
primarily to fund the Company's construction and development activities.
The Company has a line of credit totaling $5 million, all of which was
outstanding at December 31, 1998. Interest is payable monthly and, at the
Company's option, accrues at the bank's prime rate or LIBOR rate plus .75%.
On April 30, 1997, the Company entered into a $27.6 million promissory
note in conjunction with its acquisition of Kensington. Interest accrues at 10%
and is payable monthly. The amount outstanding under the agreement was
approximately $19.9 million as of December 31, 1998. The remaining funds were to
be disbursed in two phases prior to April 30, 1999, subject to certain
Rochester, Minnesota cottages and other Kensington properties achieving minimum
debt service coverage ratios. The Company's decision not to open four of the
remaining Rochester cottages until later in 1999 prevents the Company from
accessing $5.9 million of the remaining $7.7 million of additional funds. The
Company is currently in the process of negotiating an extension that will allow
it to achieve the necessary fill-up to meet the required minimum debt service
coverage ratios.
In October 1997, the Company entered into a $10.3 million construction
loan agreement for the development and construction of three assisted living
residences. Interest is payable monthly and accrues at the bank's prime rate
plus 1 1/2% during construction. In October 1999, the Company may elect, at its
option, to convert the construction loan into a term loan maturing in October
2004. Interest payments under the term loan would accrue at prime plus 1 1/2% or
an amount equal to 3.0% over the yield at the time on five-year U.S. Treasury
notes. The Company is required to maintain minimum net worth and current ratio
amounts and, if the term loan is elected, to maintain debt service coverage
ratios with respect to individual residences. At December 31, 1998, the
16
Company was in violation of net worth, tangible net worth and current ratio
covenants, which the lender has waived through the end of 1999. As of December
31, 1998, there was $7.4 million outstanding under this agreement.
In early 1998, the Company entered into construction loan agreements
totaling $20.1 million. Interest is payable monthly and accrues at LIBOR plus
2.75% or prime plus 1/2%. In December 2000, the Company may elect, at its
option, to extend the agreements up to two additional years. As of December 31,
1998, there was $19.3 million outstanding under these agreements.
See Note 6 to the Consolidated Financial Statements for further
information on the Company's long-term obligations and notes payable.
The Company currently plans to open approximately 16 new Company and
jointly-owned residences in 1999 and the second quarter of 2000. The Company has
opened one of these residences in 1999. In addition, the Company has 4 cottage
homes completed and being readied to open, has 5 residences under construction
and has obtained zoning approval for the remaining 6 residences. The 16 planned
openings do not include any cottage homes beyond the 4 cottages completed and
ready to open on the Rochester, Minnesota campus. The Company is currently
evaluating potential and existing relationships with hospitals and clinics in
order to evaluate additional alternative, broader uses of its cottage model. As
a result of these evaluations, the Company's final plan for 1999 cottages will
be announced at a later date.
The Company has been, and will continue to be, dependent on third party
financing for its acquisition and development program. The Company estimates
that newly developed residences will generally range in cost from $5.0 to $11.0
million, with the development cycle taking up to 24 months from site
identification and zoning through construction and residence opening. There can
be no assurance that financing for the Company's development program will be
available to the Company on acceptable terms, if at all. Moreover, to the extent
the Company opens properties that do not generate positive cash flow, the
Company may be required to seek additional capital for working capital and
liquidity purposes.
The Company has existing financing in place in the form of loans or
leases for the four residences that are currently completed and ready to open
and three of the residences under construction. Additional financing will be
required for the three additional residences under construction, to develop and
construct the residences not currently under construction and to refinance
certain existing indebtedness. The Company has about $6.4 million invested in
six projects staged for construction starts during early 1999 that are now
awaiting construction or lease financing. Investments in future projects will be
limited until future financing commitments are obtained. In the second quarter
of 1998, the Company completed sale/leaseback transactions for six residences.
These sale/leaseback transactions generated approximately $13 million in net
proceeds after associated mortgage repayment. The Company has not been pursuing
permanent financing for the three residences under construction pending the
outcome of the proposed merger with Sunrise. However, the Company is
continuously evaluating its financing alternatives, including traditional
mortgages, sale/leaseback transactions and other forms of off-balance sheet
financing.
The Company has funds available for working capital needs under project
financings currently in place. At this time, the Company expects to draw on six
project mortgage and lease financings to support its working capital needs in
the first and second quarters of 1999.
In addition, in the third quarter of 1998 the Company sold two parcels
of land in California for a total of $3.5 million. The net proceeds were $2.4
million after paying off a related note payable of approximately $1.1 million.
The net proceeds were used to provide additional funds to support the Company's
working capital needs.
Under the amended merger agreement described in Note 12 to Consolidated
Financial Statements, Sunrise Assisted Living, Inc. ("Sunrise") has made
available to the Company a $16.5 million line of credit to be used for
construction and development activities and working capital. The line of credit
expires in January 2000.
17
In March 1999, the Company obtained a commitment from JMAC, Inc. which
provides up to $4 million for working capital needs. Such commitment terminates
upon the earlier of the closing of the Sunrise transaction discussed in Note 12
to Consolidated Financial Statements or January 1, 2000.
See Note 13 to Consolidated Financial Statements for a discussion of
risks and uncertainties. The Company believes its existing financing
commitments, including the Sunrise line of credit, together with additional
anticipated financing, will be sufficient to fund its development, construction
and working capital needs through 1999.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
In April 1998, the Accounting Standards Executive Committee issued SOP
98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that
the costs of start-up activities and organization costs be expensed as incurred.
SOP 98-5 is effective for fiscal years beginning after December 15, 1998 with
earlier application encouraged. Management will apply the provisions of the SOP
in the first quarter of 1999. The application of SOP 98-5 will require the
Company to write-off all existing deferred preopening and organization costs and
expense all such items as incurred on a prospective basis. Deferred preopening
and organizational costs were $1.9 million at January 1, 1999.
IMPACT OF YEAR 2000
The Company has completed its review of the impact of the Year 2000
issue on its information and financial systems and is in the process of spending
about $700,000 to upgrade hardware and software to be Year 2000 compliant. The
Company is implementing a Year 2000 compliant home administrative information
system which will provide better and faster information, particularly regarding
resident history, service needs, and associated billing. This upgrade and
implementation began in the fourth quarter of 1998 and is expected to be
completed during the third quarter of 1999. This upgrade will be financed from
working capital and anticipated financing.
The Company is in the process of its review of all mechanical
equipment, including telephone systems, elevators, security systems, HVAC
systems and vehicles. The review will be completed by the end of the second
quarter of 1999. The Company believes its review is approximately 80% complete.
To date, the Company has not identified any problems or issues which would
require a significant investment of time or capital.
The efforts described above should provide the Company with an internal
solution to the Year 2000 issue. However, the Company remains cautious and
continues to review external issues that may impact the business or flow of
funds. The Company's payroll is processed by an independent third party that has
assured the Company it will be Year 2000 compliant. The Company will make
contingent plans to resort to manual operations if particular external
interfaces fail. The Company is continuing its review of Year 2000 issues.
18
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and Report of Independent Auditors required by
this Item 8 are set forth as indicated in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Pursuant to the Code of Regulations of the Company, the authorized
number of directors is eleven, divided into one class consisting of three
directors and two classes consisting of four directors each. The following
information, with respect to the principal occupation or employment, other
affiliations and business experience of each director during the last five years
has been furnished to the Company by each director. References to "the Company"
include the Company's predecessors, DevelopMed Associates, Inc. and Karrington
Operating Company. Except where indicated, each director has had the same
principal occupation for the last five years.
NAME AGE PRINCIPAL OCCUPATION
---- --- --------------------
TERMS EXPIRING IN 1999
John H. McConnell 75 Director of the Company since July 1996. Mr. McConnell is
the founder and Chairman Emeritus of Worthington
Industries, Inc. He serves on the Board of Directors of
Worthington Industries, Inc. Mr. McConnell is Chairman of
the Board of U.S. Health, Inc., a regional not-for-profit
acute care provider based in Columbus, Ohio.
Harold A. Poling 73 Director of the Company since July 1996. Mr. Poling is
the retired Chairman of the Board of Ford Motor Company
and also serves on the Board of Directors of Shell Oil
Company, The LTV Corporation, Kellogg Company and Meritor
Automotive, Inc.
Richard R. Slager 45 Co-founder of the Company; Chairman of the Board of the
Company since April 1996 and Chief Executive Officer since
the Company's formation in 1990.
Robert D. Walter 53 Director of the Company since July 1996. Mr. Walter is
the Chairman and Chief Executive Officer
19
of Cardinal Health, Inc., a Dublin, Ohio based health care service
provider. Mr. Walter serves on the Board of Directors of
Bank One Corporation and CBS Corporation.
TERMS EXPIRING IN 2000
Bernadine P. Healy 54 Director of the Company since July 1996. Dr. Healy has
served as Dean of Medicine and as a Professor of Internal
Medicine at The Ohio State University since October 1995.
Prior thereto she was Senior Policy Advisor of The Page
Center, The Cleveland Clinic Foundation. From 1991 to
1993, Dr. Healy was the Director of the National
Institutes of Health. Dr. Healy serves on the Board of
Directors of National City Corp., Invacare, Medtronics,
Inc. and Ashland, Inc.
Pete A. Klisares 63 President and Chief Operating Officer of the Company since
August 1997. Prior to joining the Company, Mr. Klisares
served as Executive Vice President of Worthington
Industries, Inc. from August 1993 to July 1997 and as an
assistant to the Chairman from December 1991 to July
1993. Mr. Klisares also serves on the Board of Directors
of Worthington Industries, Inc., Dominion Homes, Inc.,
Huntington National Bank, N.A., and MPWG, Inc.
Michael H. Thomas 49 Director of the Company since May 1996. Mr. Thomas is a
certified public accountant and was employed by JMAC as
its Executive Vice President and Treasurer until May 31,
1998.
TERMS EXPIRING IN 2001
John S. Christie 50 Director of the Company since May 1996. Since October 1,
1995, Mr. Christie has been the President of JMAC. Prior
to 1995, Mr. Christie was Senior Vice President, Corporate
Development, of The Battelle Memorial Institute, the
world's largest private research organization, based in
Columbus, Ohio. Mr. Christie serves on the Board of
Directors of Neoprobe Corporation.
David H. Hoag 59 Director of the Company since July 1996. Mr. Hoag retired
from LTV Corporation on February 1, 1999. He was Chairman
and Chief Executive Officer of LTV Corporation during the
five years ended September 1, 1998, and Chairman through
his retirement date. The LTV Corporation completed a
reorganization under Chapter 11 of the U.S. Bankruptcy
Code in June 1993. Mr. Hoag serves on the Board of
Directors of The Chubb Corporation and Lubrizol
Corporation.
Charles H. McCreary 46 Secretary of the Company since May 1996; Director of the
Company since July 1996. Mr. McCreary is a
20
partner in the law firm of Bricker & Eckler, which firm
has represented the Company since its formation.
James V. Pickett 57 Director of the Company since July 1996. Mr. Pickett has
served as Chairman of Pickett Realty Advisors, a Dublin,
Ohio-based asset manager for a hotel portfolio, since
1965, and, in addition, has served as the Vice Chairman
since 1997 and the Managing Director from 1993 to 1997 of
Bank One Capital Corporation, a real estate investment
group. Mr. Pickett serves on the Board of Directors of
Wendy's International, Inc. and Metatec Corporation.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Ownership of and transactions in the common shares of the Company by
executive officers, directors and persons who own more than 10% of the common
shares are required to be reported to the SEC pursuant to Section 16 of the
Securities Exchange Act of 1934. Based solely on a review of the copies of
reports furnished to the Company and representations of certain executive
officers and directors, the Company believes that during fiscal 1998 its
officers, directors and greater than 10% beneficial owners complied with such
filing requirements, except Thomas J. Klimback, former Chief Financial Officer,
who resigned in December 1998. Mr. Klimback failed to file a Form 5 for 1998 for
stock options granted during 1998 (see "Executive Compensation - Grants of
Options" for description of transaction and "Executive Compensation - Option
Exercises and Holdings" for unexercised options as of December 31, 1998).
EXECUTIVE OFFICERS
The following table sets forth certain information regarding each of
the Company's executive officers:
NAME AGE POSITION
- ---- --- --------
Richard R. Slager .......................... 45 Chairman of the Board and Chief Executive Officer
Pete A. Klisares............................ 63 Director, President and Chief Operating Officer
Stephen Lewis .............................. 53 Senior Vice President, Development, General Counsel and
Assistant Secretary
Mark N. Mace .............................. 43 Senior Vice President, Finance and Treasurer
Charles H. McCreary ....................... 46 Director and Secretary
For additional information regarding Messrs. Slager, Klisares and
McCreary, see "Directors" above.
Stephen Lewis has served as Senior Vice President, Development and
General Counsel of the Company since November 1993. Prior to joining the
Company, Mr. Lewis was general counsel of VOCA Corporation, a multi-state
operator of residential centers for persons with mental retardation and other
developmental disabilities.
Mark N. Mace has served as Senior Vice President, Finance and Treasurer
of the Company since March 1996. Prior to joining the Company, Mr. Mace was a
Senior Manager with Deloitte & Touche LLP, a national accounting firm.
Officers serve at the pleasure of the Board of Directors.
21
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
The following table shows, for the years ended December 31, 1998, 1997
and 1996, compensation awarded or paid to, or earned by, the Company's Chief
Executive Officer, the four most highly compensated executive officers of the
Company whose compensation exceeded $100,000 and two individuals for whom
disclosure would have been provided but for the fact that such individuals were
not serving as an executive officer for the Company at the end of 1998 (the
"Named Executive Officers").
SUMMARY COMPENSATION TABLE
ANNUAL LONG-TERM
COMPENSATION COMPENSATION
--------------------------- ---------------
SECURITIES ALL OTHER
UNDERLYING COMPENSATION
FISCAL SALARY BONUS (1) OPTIONS (2)
NAME AND PRINCIPAL POSITION YEAR ($) ($) (#) ($)
- ---------------------------------- --------- ------------ -- ----------- --------------- ----------------
Richard R. Slager............ 1998 220,000 65,000 25,000 7,579
Chairman of the Board 1997 220,000 45,147 40,000 6,526
and Chief Executive 1996 191,154 46,954 20,000 5,417
Officer
Pete A. Klisares (3)......... 1998 150,000 46,000 30,000 6,990
President and Chief 1997 55,385 14,000 50,000 0
Operating Officer
Stephen Lewis................ 1998 100,181 13,000 7,500 0
Senior Vice President, 1997 97,169 2,927 0 0
Development, General 1996 90,380 24,674 7,500 0
Counsel and Assistant
Secretary
Mark N. Mace (4)............. 1998 100,000 13,000 5,000 0
Senior Vice President, 1997 97,407 6,255 2,500 0
Finance and Treasurer 1996 75,308 5,463 7,500 0
John K. Knutson (5).......... 1998 123,311 21,000 27,500 20,000
Executive Vice President, 1997 129,960 21,480 5,000 13,137
Operations 1996 101,424 15,000 7,500 33,323
Thomas J. Klimback (6)....... 1998 130,000 24,000 10,000 93,100
Chief Financial Officer 1997 25,000 8,000 50,000 0
- ---------------
(1) The Named Executive Officers participate in the Company's profit
sharing plan together with substantially all the employees of the
Company. For residence employees, profit sharing is based on the
operating profit of the residence. For other employees, profit sharing
is based on the overall results of the Company. Cash payments are made
quarterly.
(2) All Other Compensation for the Named Executive Officers consists of:
(i) on behalf of Mr. Slager, life insurance premiums paid by the
Company in 1996 and automobile lease payments paid by the Company in
1998 and 1997; (ii) on behalf of Mr. Klisares, automobile lease
payments paid by the Company in 1998; (iii) on behalf of Mr. Knutson,
forgiveness of an amount owed to the Company by Mr. Knutson in 1998 and
moving and relocation
22
expenses paid by the Company in 1997 and 1996; and (iv) on behalf of
Mr. Klimback, severance payments of $67,500 and moving and relocation
expenses paid by the Company.
(3) In August 1997, Mr. Klisares was hired as the Company's President and
Chief Operating Officer at an annual salary of $150,000.
(4) In March 1996, Mr. Mace was hired as the Company's Senior Vice
President, Finance and Treasurer at an annual salary of $87,500.
(5) In February 1996, Mr. Knutson was hired as the Company's Senior Vice
President of Operations for an annual base salary of $120,000. In
September 1998, the Company accepted Mr. Knutson's resignation.
(6) In October 1997, Mr. Klimback was hired as the Company's Chief
Financial Officer at an annual salary of $130,000. Mr. Klimback
resigned in December 1998.
GRANTS OF OPTIONS
The following table sets forth information concerning individual grants
of options made during 1998 to each of the Named Executive Officers. The Company
has never granted stock appreciation rights.
OPTION GRANTS IN THE LAST FISCAL YEAR
Individual Grants (1)
- -------------------------------------------------------------------------------------- Potential Realizable
% of Value at Assumed
Number of Total Annual Rates of Stock
Securities Options Price Appreciation
Underlying Granted to Exercise FOR OPTION TERM (2)
Options Employees in Price Expiration ----------------------
Name Granted (#) Fiscal Year ($/Share) Date 5%($) 10%($)
---- ----------- ----------- --------- ---- ----- ------
Richard R. Slager 25,000 12.8% 9.00 08/11/2008 141,500 358,500
Pete A. Klisares 30,000 15.4% 9.00 08/11/2008 169,800 430,200
Stephen Lewis 7,500 3.8% 9.00 08/11/2008 42,450 107,550
Mark N. Mace 5,000 2.6% 9.00 08/11/2008 28,300 71,700
John K. Knutson 27,500 14.1% 9.00 (3) - -
Thomas J. Klimback 10,000 5.1% 9.00 (3) - -
- --------------
(1) All options are non-qualified options granted under the Company's 1996
Incentive Stock Plan. All above options become exercisable in four
equal annual portions commencing on the second anniversary of the date
of grant, except Mr. Klisares' options which become exercisable in four
equal quarterly portions commencing December 31, 1998. If the Company
experiences a change of control, all of Mr. Klisares' remaining
unvested options shall immediately vest.
(2) The amounts reflected in this table represent certain assumed rates of
appreciation only. Actual realized values, if any, on option exercises
will be dependent on the actual appreciation of the common shares of
the Company over the term of the options. There can be no assurances
that the potential realizable values reflected in this table will be
achieved.
(3) Officers resigned in 1998 and options have expired.
23
OPTION EXERCISES AND HOLDINGS
The following table sets forth information with respect to unexercised
options and the value of unexercised in-the-money options as of December 31,
1998, held by each of the Named Executive Officers. No options were exercised
during 1998.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Number of Value of
Securities Unexercised
Underlying In-the-Money
Unexercised Options Options at
at Fiscal Year-End (#) Fiscal Year End ($)
------------------------------------ ------------------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------ ---------------- ----------------- ----------------- -----------------
Richard R. Slager 5,000 80,000 16,250 365,000
Pete A. Klisares 57,500 22,500 304,375 163,125
Stephen Lewis 1,875 13,125 6,094 72,656
Mark N. Mace 1,875 13,125 6,094 67,656
John K. Knutson - - - -
Thomas J. Klimback 15,625 34,375 52,734 116,016
EMPLOYMENT AGREEMENTS
In connection with the proposed merger between the Company and Sunrise
Assisted Living, Inc., Richard R. Slager, the Company's Chairman and Chief
Executive Officer, entered into a new employment agreement with the Company for
a term of six months following the closing of the merger. The new employment
agreement requires Mr. Slager to devote full-time to his duties, and entitles
Mr. Slager to receive:
- an annual salary of $175,000;
- a payment of $145,000 upon the closing of the merger, of which
$100,000 will be a prepayment in exchange for an agreement not
to compete;
- a payment of $440,000 from the Company upon the earlier of six
months following the merger or his termination of employment;
and
- upon termination of his employment, title to the Company
automobile used by him.
In connection with the merger, Pete A. Klisares, the Company's
President, also entered into a new employment agreement with the Company for a
term of six months following the closing of the merger. The new employment
agreement requires Mr. Klisares to devote approximately one-half time to his
duties, and entitles Mr. Klisares to receive:
- a base salary of $600 per business day;
- a payment of $18,000 upon the closing of the merger;
- a payment of $150,000 from the Company upon the earlier of six
months following the merger or his termination of employment;
and
- upon the closing of the merger, title to the Company
automobile used by him.
In the aggregate, Mr. Slager's employment benefits total approximately
$722,000 and Mr. Klisares' employment benefits total approximately $257,000.
24
COMPENSATION OF DIRECTORS
Directors who are officers or employees of the Company receive no
additional compensation for their services as members of the Board of Directors
or as members of Board committees. Directors who are not officers or employees
of the Company are paid a quarterly fee of $3,000, as well as additional fees of
$1,000 for each meeting of the Board or of a Board committee attended by such
Director. The Company's Directors are reimbursed for their out-of-pocket
expenses incurred in connection with their service as directors, including
travel expenses. In addition, pursuant to the Plan, each Director who is not an
employee of the Company receives a grant of an option to purchase 6,000 common
shares upon his or her election as a director and an annual option thereafter to
purchase 2,000 common shares.
COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors of the Company is
comprised of four outside directors, none of whom is or was formerly an officer
of the Company. The members of the Compensation Committee are Bernadine P.
Healy, John S. Christie, John H. McConnell and David H. Hoag.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to each
person known by the Company to own beneficially more than five percent of any
class of the Company's voting securities. The Company believes that each
individual or entity named has sole investment and voting power with respect to
the Common Shares indicated as beneficially owned by such individual or entity,
except as otherwise noted.
Name and Address of Amount and Nature of Percent of
Beneficial Owner Beneficial Ownership Class
------------------- -------------------- ----------
JMAC, Inc. 2,250,000 (5) 32.9%
150 E. Wilson Bridge Road, Suite 230
Worthington, Ohio 43085
John H. McConnell 2,265,800 (1)(2)(5) 33.1%
150 E. Wilson Bridge Road, Suite 230
Worthington, Ohio 43085
Richard R. Slager 730,020 (3)(5) 10.7%
Karrington Health, Inc.
919 Old Henderson Road
Columbus, Ohio 43220
Ohio PERS 600,000 (4) 8.8%
277 East Town Street
Columbus, Ohio 43215
Alan B. Satterwhite 560,110 (4) 8.2%
Famous Photography, Inc.
4663 Kenny Road
Columbus, Ohio 43220
- -------------
(1) Includes currently exercisable options to purchase 10,000 common shares
and 800 common shares held of record by Mr. McConnell's wife with
respect to which he disclaims beneficial ownership.
(2) Includes all of the common shares held of record by JMAC, Inc.
("JMAC"). Mr. McConnell is the Chairman of the Board of JMAC, and the
directors of JMAC have given him sole voting and investment power in
the common shares of the Company held by it.
(3) Includes 200,000 common shares held of record by Mr. Slager's wife with
respect to which he disclaims beneficial ownership and currently
exercisable options to purchase 5,000 shares.
(4) Based upon filings with the Securities and Exchange Commission.
(5) Each of the Company's executive officers and directors and JMAC, Inc.
has entered into a
25
shareholder's agreement with Sunrise Assisted Living, Inc. ("Sunrise").
Under these shareholder agreements, the Company's directors and
executive officers and JMAC, Inc. each granted Sunrise an irrevocable
proxy to vote all of their Company common shares in favor of the
amended merger agreement and against any competing third party
transaction.
The following table sets forth the number and percentage of outstanding
common shares beneficially owned as of March 15, 1998 by (i) each director of
the Company; (ii) each executive officer of the Company included in the Summary
Compensation Table; and (iii) all directors and executive officers of the
Company as a group. The Company believes that each individual or entity named
has sole investment and voting power with respect to the common shares indicated
as beneficially owned by such individual or entity, except as otherwise noted.
NAME OF AMOUNT AND NATURE OF PERCENT OF
BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS (1)
- ---------------- -------------------- ----------
Sunrise Assisted Living, Inc. 3,038,068 (12) 44.4%
Richard R. Slager 730,020 (2)(11) 1.0%
Pete A. Klisares 71,675 (3)(11) *
Stephen Lewis 2,175 (4)(11) *
Mark N. Mace 3,803 (5)(11) *
John K. Knutson 0 *
Thomas J. Klimback 18,750 (13) *
Charles H. McCreary 12,970 (6)(7)(11) *
Michael H. Thomas 16,000 (6)(11) *
John S. Christie 13,700 (6)(8)(11) *
Bernadine P. Healy 11,300 (6)(11) *
David H. Hoag 12,000 (6)(11) *
John H. McConnell 2,265,800 (9)(11) 33.1%
James V. Pickett 13,000 (6)(10)(11) *
Harold A. Poling 20,000 (6)(11) *
Robert D. Walter 30,000 (6)(11) *
All directors and executive
officers as a group (13 persons) 3,202,443 (2)(7)(8)(9)(10)(11)(12) 45.7%
- -------------
* Less than 1%.
(1) The percent of class is based upon the sum of (i) 6,839,368 common
shares outstanding on March 15, 1999 and (ii) the number of common
shares as to which the named person has the right to acquire beneficial
ownership upon the exercise of options under the Karrington Health,
Inc. 1996 Incentive Stock Plan (the "Plan") which are exercisable
within 60 days of March 15, 1999.
(2) See Note 3 to preceding table.
(3) Includes currently exercisable options to purchase 65,000 common
shares.
(4) Includes currently exercisable options to purchase 1,875 common shares.
(5) Includes currently exercisable options to purchase 2,500 common shares.
(6) Includes currently exercisable options to purchase 10,000 common
shares.
(7) Includes 1,700 common shares as to which Mr. McCreary has shared voting
and investment power with his wife and 970 common shares held by Mr.
McCreary as custodian for his minor children.
(8) Includes 500 common shares to which Mr. Christie has shared voting and
investment power.
(9) See Notes 1 and 2 to preceding table.
(10) Includes 3,000 common shares as to which Mr. Pickett has shared voting
and investment power.
26
(11) Includes currently exercisable options to purchase 164,375 common
shares.
(12) On October 18, 1998, the Company and Sunrise Assisted Living, Inc.
("Sunrise"), a provider of assisted living for seniors, entered into a
definitive agreement, as amended March 4, 1999, for Sunrise to acquire
the Company in a tax-free, stock-for-stock transaction valued at
approximately $94.9 million. Under the merger agreement, as amended,
the Company would become a wholly owned subsidiary of Sunrise, and each
issued and outstanding share of the Company's common stock would be
automatically converted into the right to receive 0.3333 shares of
Sunrise common stock. Sunrise expects to account for the acquisition of
the Company using the purchase method of accounting. Each of the
Company's executive officers and directors has entered into shareholder
agreements with Sunrise. Under these shareholder agreements, the
Company's directors and executive officers each granted Sunrise an
irrevocable proxy to vote all of their Company common shares in favor
of the amended merger agreement and against any competing third party
transaction.
(13) Includes currently exercisable options to purchase 18,750 common
shares.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In September 1997, the Company entered into a $7.5 million promissory
note with JMAC, Inc., an investment company owned by John H. McConnell and John
P. McConnell, the Founder and Chairman, respectively, of Worthington Industries,
Inc., pursuant to which JMAC agreed to provide up to $7.5 million in loans to
the Company during a commitment period expiring in January 2000. Interest is
payable monthly and accrues at a bank's prime rate. Interest cost incurred in
1998 was $660,000 with respect to this agreement. The amount outstanding at
December 31, 1998 and as of March 15, 1999 was $7.5 million.
In March 1999, JMAC provided a $4.0 commitment to the Company for
working capital needs which terminates the earlier of the closing of the Sunrise
merger or January 1, 2000.
On April 1, 1998, the Company entered into a $4.0 million promissory
note with JMAC pursuant to which JMAC agreed to provide up to $4.0 million in
loans to the Company during a commitment period expiring on the earlier of (i)
June 30, 1998 or (ii) the closing of a specific sale/leaseback transaction.
Interest was payable monthly and accrued at a bank's prime rate. The amount
outstanding of $3.5 million was repaid in April 1998 at which time the
commitment expired.
Charles H. McCreary, the Company's Secretary and a Director, is a
partner in the law firm of Bricker & Eckler, which provides legal services to
the Company in connection with a variety of business and organizational matters.
27
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1)&(2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
See index to financial statements and financial statement schedules at
page F-1.
(3) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
2.1 Stock Purchase Agreement dated April 24, 1997 by and among
Kensington Cottages Corporation of America, Karrington Health,
Inc., Kensington Cottages Corporation of Minnesota and the
individual shareholders of Kensington Cottages Corporation of
Minnesota (2)
2.2 Agreement and Plan of Merger dated April 24, 1997 by and among
Karrington Health, Inc., Kensington Mergeco, Inc., Kensington
Management Group, Inc., and Jon D. Rappaport (2)
2.3 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Buffalo Hills
Residence and Jon D. Rappaport (2)
2.4 Asset Purchase Agreement dated April 24, 1997, by and among Kensington
Cottages Corporation of America, Karrington Health, Inc.,
Centex-Kensington (Mankato I) Partnership, Centex Senior Services
Corporation, Centex Life Solutions, Inc., Kensington Cottages
Corporation of Mankato and Jon D. Rappaport (2)
2.5 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of North Dakota and the individual shareholders of
Kensington Cottages Corporation of North Dakota (2)
2.6 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of Rochester and Jon D. Rappaport (2)
2.7 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of Iowa and the individual shareholders of
Kensington Cottages Corporation of Iowa (2)
2.8 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Bismarck
Investors, Kensington Living Centers, Inc. and Jon D. Rappaport (2)
2.9 Agreement of merger dated October 18, 1998 by and among Karrington
Health, Inc. and Sunrise Assisted Living, Inc. (3)
2.10 Amendment No. 1 to agreement of merger, dated as of March 4, 1999 by
and among Karrington Health, Inc. and Sunrise Assisted Living, Inc. (4)
3.1 Form of Amended Articles of Incorporation of the Company (1)
28
3.2 Form of Code of Regulations of the Company (1)
10.1 1996 Incentive Stock Plan * (1)
10.4 Registration Rights Agreement dated May 8, 1996, by and among the
Company and the Investors (as defined therein) (1)
10.6 Letter of Intent dated April 29, 1996, by and between the Company and
Sisters of Charity Health Care Systems, Inc. (1)
21 Subsidiaries of the Registrant (6)
23.1 Consent of Ernst & Young LLP (6)
24.1 Power of Attorney - Richard R. Slager (6)
24.2 Power of Attorney - Pete A. Klisares (6)
24.3 Power of Attorney - Mark N. Mace (6)
24.4 Power of Attorney - Charles S. McCreary (6)
24.5 Power of Attorney - John S. Christie (6)
24.6 Power of Attorney - Bernadine P. Healy (6)
24.7 Power of Attorney - David H. Hoag (6)
24.8 Power of Attorney - John H. McConnell (6)
24.9 Power of Attorney - James V. Pickett (6)
24.10 Power of Attorney - Harold A. Poling (6)
24.11 Power of Attorney - Michael H. Thomas (6)
24.12 Power of Attorney - Robert D. Walter (6)
27 Financial Data Schedule (7) (6)
99.1 Option Agreement dated October 18, 1998 by and among Karrington Health,
Inc. and Sunrise Assisted Living, Inc. (5)
99.2 Form of Shareholder Agreement dated October 18, 1998 by and among
Karrington Health, Inc. and Karrington Health, Inc. affiliates, for the
benefit of Sunrise Assisted Living, Inc. (5)
99.3 Safe Harbor Under the Private Securities Litigation Reform Act of 1995 (6)
-------------------
(1) Included as an exhibit by the same number in the Company's
Registration Statement on Form S-1 (File No. 333-03491) and
incorporated herein by reference.
(2) Included as an exhibit by the same number in the Company's
Form 8-K/A filed on May 21, 1997 and incorporated herein by
reference.
(3) Included as exhibit 2.1 to the Company's report on Form 8K
dated October 30, 1998 and incorporated herein by reference.
(4) Included as exhibit 2.1 to the Company's report on Form 8K
dated March 5, 1998 and incorporated herein by reference.
(5) Included as an exhibit by the same number in the Company's
report on Form 8K dated October 30, 1998 and incorporated
herein by reference.
(6) Filed herewith.
(7) No restated Financial Data Schedules are required to be filed.
29
* Management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K
The Company's current report on Form 8-K filed with the Securities and
Exchange Commission on October 30, 1998 reported under Item 5, Other
Events, that as of October 18, 1998, the Company had entered into an
agreement of merger with Sunrise Assisted Living, Inc.
(c) EXHIBITS
Exhibits filed with this Annual Report on Form 10-K are attached
hereto. For a list of such exhibits, see Item 14 (a) (3).
(d) FINANCIAL STATEMENT SCHEDULES
Financial statement schedules filed with this Annual Report on Form
10-K are attached hereto. For a list of such schedules, see Item
14(a)(2).
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
and Exchange Act of 1934, as amended, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Karrington Health, Inc.
By: /S/ RICHARD R. SLAGER
-----------------------
Richard R. Slager
Chairman of the Board
Date: March 30, 1999
Pursuant to the requirements of the Securities Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/S/ RICHARD R. SLAGER Chairman of the Board and Chief Executive March 30, 1999
- -----------------------
Richard R. Slager Officer (Principal Executive Officer)
/S/ PETE A. KLISARES * President, Chief Operating Officer and Director March 30, 1999
- -----------------------
Pete A. Klisares
/S/ MARK N. MACE * Senior Vice President, Finance and Treasurer March 30, 1999
- --------------------
Mark N. Mace (Principal Financial and Accounting Officer)
/S/ CHARLES H. MCCREARY* Secretary and Director March 30, 1999
- --------------------------
Charles H. McCreary
/S/ JOHN S. CHRISTIE * Director March 30, 1999
- ------------------------
John S. Christie
/S/ BERNADINE P. HEALY, M.D. * Director March 30, 1999
- -------------------------------
Bernadine P. Healy, M.D.
/S/ DAVID H. HOAG * Director March 30, 1999
- --------------------
David H. Hoag
/S/ JOHN H. MCCONNELL * Director March 30, 1999
- ------------------------
John H. McConnell
/S/ JAMES V. PICKETT * Director March 30, 1999
- -----------------------
James V. Pickett
/S/ HAROLD A. POLING * Director March 30, 1999
- -----------------------
Harold A. Poling
/S/ MICHAEL H. THOMAS * Director March 30, 1999
- ------------------------
Michael H. Thomas
/S/ ROBERT D. WALTER * Director March 30, 1999
- ------------------------
Robert D. Walter
* By: /S/ RICHARD R. SLAGER
-----------------------
Richard R. Slager
(Attorney-in-Fact)
31
KARRINGTON HEALTH, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
(ITEMS 14 (a) (1) AND (2) )
1. DESCRIPTION OF FINANCIAL STATEMENTS PAGE
----
Report of Independent Auditors F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
2. FINANCIAL STATEMENT SCHEDULES PAGE
----
Schedule II - Valuation and Qualifying Accounts F - 20
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
F-1
REPORT OF INDEPENDENT AUDITORS
TO THE SHAREHOLDERS OF KARRINGTON HEALTH, INC.
We have audited the accompanying consolidated balance sheets of
Karrington Health, Inc. and subsidiaries (the "Company") as of December 31, 1998
and 1997, and the related consolidated statements of operations, equity, and
cash flows for each of the three years in the period ended December 31, 1998.
Our audits also include the financial statement schedule listed in the index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Karrington Health, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Columbus, Ohio
March 5, 1999
F-2
KARRINGTON HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------------------------
1998 1997
------------------ -- -------------------
ASSETS
Current assets:
Cash and cash equivalents .................... $ 2,737,566 $ 4,370,488
Receivables:
Trade .................................... 1,157,492 482,597
Due from lessor .......................... 1,727,011 4,330,981
Affiliates ............................... 837,650 649,172
Land sold subject to put right ............. 2,100,000 --
Prepaid expenses ........................... 903,209 281,722
------------- -------------
Total current assets ..................... 9,462,928 10,114,960
Property and equipment - net ...................... 117,248,600 115,983,043
Costs in excess of net assets acquired - net ...... 8,081,542 8,231,073
Other assets - net ................................ 6,379,419 6,986,724
------------- -------------
Total assets ............................. $ 141,172,489 $ 141,315,800
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities ..... $ 4,537,435 $ 2,535,969
Construction payables ........................ 2,932,032 4,717,230
Deposit on sale of land ...................... 2,100,000 --
Notes payable ................................ 10,326,011 6,000,000
Payroll and related taxes .................... 895,054 1,080,884
Unearned resident fees ....................... 969,459 861,266
Interest payable ............................. 747,426 614,919
Current portion of long-term obligations ..... 392,549 998,523
------------- -------------
Total current liabilities ................ 22,899,966 16,808,791
Long-term debt, less current portion .............. 95,752,693 97,067,298
Deferred gain on sale/leasebacks .................. 9,125,532 --
Other long-term obligations ....................... 1,069,687 440,169
Deferred income taxes ............................. 493,000 493,000
Minority interests ................................ 784,226 --
Shareholders' equity:
Common shares, without par value ............. 33,501,855 33,484,712
Accumulated deficit .......................... (22,454,470) (6,978,170)
------------- -------------
Total shareholders' equity ............... 11,047,385 26,506,542
------------- -------------
Total liabilities and shareholders' equity $ 141,172,489 $ 141,315,800
------------- -------------
------------- -------------
See accompanying notes.
F-3
KARRINGTON HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Revenues:
Residence operations ................... $ 33,883,433 $ 18,538,832 $ 8,952,759
Development and project
management fees ..................... 942,062 681,051 642,803
------------ ------------ ------------
Total revenues ..................... 34,825,495 19,219,883 9,595,562
Expenses:
Residence operations ................... 28,289,171 13,683,245 6,485,837
General and administrative ............. 6,465,454 4,432,635 2,772,727
Depreciation and amortization .......... 5,231,678 2,684,297 1,379,060
Rent expense ........................... 3,992,822 259,114 89,121
Unusual charges ........................ -- 1,380,000 --
------------ ------------ ------------
Total expenses ..................... 43,979,125 22,439,291 10,726,745
------------ ------------ ------------
Operating income (loss) ..................... (9,153,630) (3,219,408) (1,131,183)
Interest expense ............................ (5,882,378) (2,743,353) (1,271,561)
Interest income ............................. 337,490 348,711 470,065
Equity in net loss of unconsolidated entities (631,556) (246,354) (7,157)
Minority interest of consolidated entity..... 193,774 -- --
------------ ------------ ------------
Loss before income taxes .................... (15,136,300) (5,860,404) (1,939,836)
Income tax benefit (provision) .............. (340,000) 190,000 (683,000)
------------ ------------ ------------
Net loss .................................... $(15,476,300) $ (5,670,404) $ (2,622,836)
------------ ------------ ------------
------------ ------------ ------------
Net loss per common share - basic and
diluted ................................ $ (2.26) $ (.83)
Weighted average number of common
shares outstanding ..................... 6,838,400 6,792,200
See accompanying notes.
F-4
KARRINGTON HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
COMMON SHARES ACCUMULATED PARTNERS'
SHARES AMOUNT DEFICIT EQUITY TOTAL
----------------------------------------------------------------------------------
Balance at January 1, 1996.......... -- -- -- $ 5,840,907 $ 5,840,907
Net loss........................ -- -- $ (1,307,766) (1,315,070) (2,622,836)
Reorganization transaction...... 4,350,000 $ 4,525,837 -- (4,525,837) --
Net proceeds from public
offering..................... 2,350,000 27,458,875 -- -- 27,458,875
----------------------------------------------------------------------------------
Balance at December 31, 1996........ 6,700,000 31,984,712 (1,307,766) -- 30,676,946
Net loss........................ -- -- (5,670,404) -- (5,670,404)
Common shares issued............ 137,363 1,500,000 -- -- 1,500,000
----------------------------------------------------------------------------------
Balance at December 31, 1997........ 6,837,363 33,484,712 (6,978,170) -- 26,506,542
Net loss...................... -- -- (15,476,300) -- (15,476,300)
Common shares issued.......... 2,005 17,143 -- -- 17,143
----------------------------------------------------------------------------------
Balance at December 31, 1998........ 6,839,368 $ 33,501,855 $ (22,454,470) $ -- $ 11,047,385
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
See accompanying notes.
F-5
KARRINGTON HEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1998 1997 1996
------------- ------------- -------------
OPERATING ACTIVITIES
Net loss ........................................................... $(15,476,300) $ (5,670,404) $ (2,622,836)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for terminated projects and unusual
charges ....................................................... 885,000 1,191,909 --
Depreciation and amortization ................................... 5,231,678 2,684,297 1,379,060
Minority interest ............................................... (193,774) -- --
Deferred income taxes ........................................... -- (190,000) 683,000
Loss on disposal of assets ...................................... -- -- 10,060
Equity in net loss of unconsolidated entities.................... 631,556 246,354 7,157
Change in operating assets and liabilities:
Receivables ................................................... 2,617,509 (4,370,716) (17,016)
Prepaid expenses .............................................. (621,487) (2,417,333) (71,433)
Pre-opening costs ............................................. (3,181,354) (1,316,495) (639,908)
Accounts payable and accrued
Liabilities ........................................... 2,602,069 5,445,275 174,268
Other assets and liabilities .................................. (180,906) 456,646 166,870
------------- ------------- -------------
Net cash used in operating activities ........................... (7,686,009) (3,940,467) (930,778)
INVESTING ACTIVITIES
Purchases of property and equipment ................................ (42,744,414) (56,234,016) (25,670,838)
Decrease (increase) in escrow balances ............................. (1,035,690) 587,811 (1,146,004)
Equity contributions to unconsolidated entities .................... -- -- (1,347,753)
Distributions from unconsolidated entity ........................... 200,000 225,000 339,767
Acquisition of Kensington - net of cash acquired ................... -- (4,182,733) --
Proceeds from sale of assets ....................................... 41,632,582 6,010,832 101,202
------------- ------------- -------------
Net cash used in investing activities............................ (1,947,522) (53,593,106) (27,723,626)
FINANCING ACTIVITIES
Net proceeds from common stock issuance ............................ 17,143 -- 27,458,875
Proceeds from notes payable ........................................ 4,326,011 6,000,000 --
Proceeds from mortgages ............................................ 31,436,446 37,516,826 21,744,390
Repayment of mortgages ............................................. (27,759,794) (1,258,852) (7,165,025)
Proceeds from affiliated entity .................................... -- 7,500,000 5,501,535
Repayment of amounts due affiliated entity ......................... -- -- (5,535,375)
Payments of financing fees ......................................... (997,197) (137,098) (1,211,644)
Minority interest capital contribution ............................. 978,000 -- --
------------- ------------- -------------
Net cash provided by financing activities ....................... 8,000,609 49,620,876 40,792,756
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents ................... (1,632,922) (7,912,697) 12,138,352
Cash and cash equivalents at beginning of year ..................... 4,370,488 12,283,185 144,833
------------- ------------- -------------
Cash and cash equivalents at end of year ........................... $ 2,737,566 $ 4,370,488 $ 12,283,185
------------- ------------- -------------
------------- ------------- -------------
Supplemental disclosure of cash flow Information:
Cash paid for interest ............................................. $ 7,333,293 $ 4,653,534 $ 2,280,810
See accompanying notes
F-6
KARRINGTON HEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. DESCRIPTION OF THE BUSINESS
The Company is a developer, owner and operator of licensed, assisted
living residences which provides quality professional, personal and health-care
services, including an emphasis on Alzheimer's care, for individuals needing
assistance with activities of daily living. These activities include bathing,
dressing, meal preparation, housekeeping, taking medications, transportation,
and other activities that, because of the residents' conditions, are difficult
for residents to accomplish in an independent living setting. The Company offers
its customers a dignified residential environment focused on quality of life.
The Company also provides development, support and management services to its
joint ventures and others in the long-term care industry. As of December 31,
1998, the Company, including joint ventures, had 40 residences open in Ohio,
Michigan, Pennsylvania, Indiana, Illinois, Minnesota, North Carolina, North
Dakota, Iowa, Colorado and New Mexico and 10 residences under construction in
Ohio, Minnesota, North Carolina and Michigan.
Karrington Health, Inc. was incorporated in April 1996 to become the
parent of Karrington Operating Company (Karrington Operating) upon the
consummation of the reorganization transactions which occurred immediately prior
to the effective date of the registration statement (see Note 9). Hereinafter,
all references to the "Company" encompass Karrington Operating and Karrington
Health, Inc. Karrington Operating was an Ohio General Partnership founded in
1991 by DevelopMed Associates, Inc. (Associates) and JMAC Properties, Inc., a
private investment company, the principal shareholder of which is JMAC, Inc.
(JMAC). Effective December 31, 1996, the net assets of Karrington Operating and
three other related partnerships were distributed to new subsidiary corporations
of Karrington Health, Inc. The trade name "Karrington Communities," a Registered
Trademark, is the operating name of all residences owned and operated by the
Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements reflect the operations and
development activities of the Company, including all wholly-owned subsidiaries
and a majority-owned entity. Significant intercompany transactions and accounts
are eliminated in consolidation. The minority interests on the December 31, 1998
balance sheet and in the 1998 statement of operations represent a 30% interest
in an assisted living residence located in Chicago, Illinois that opened in
October 1998. The Company owns a 70% controlling interest in the project that it
developed, constructed and manages. Accordingly, the Company consolidates the
balance sheet and results of operations of this residence.
DISCLOSURES ABOUT SEGMENTS
The Company is required to adopt the disclosure provisions of Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" as of December 31, 1998. The Company has
determined that it has just one reportable segment as described in Note 1.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosures of contingent assets and liabilities and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from the estimates.
F-7
INVESTMENT IN UNCONSOLIDATED ENTITIES
The Company uses the equity method of accounting for its investments in
its 19.9%-50% jointly-owned ventures, which were formed to operate assisted
living residences (see Note 7).
REVENUE RECOGNITION
The Company recognizes assisted living service fee revenue in the
period in which it is earned. Payments received in advance are reflected as
unearned resident fees in the accompanying consolidated financial statements.
Community fees are payments received from residents at move in and may be
refundable ratably over three months from the date of admission if the resident
moves out. Community fees are recognized as revenue when received less an
estimate of the amount that may be refunded. The Company performs development
and project management consulting services for its joint ventures and recognizes
revenue for these fees as the services are provided.
CASH EQUIVALENTS
The Company considers all liquid investments purchased with a maturity
of three months or less to be cash equivalents. The carrying value of cash
equivalents approximates their fair value.
RECEIVABLES DUE FROM LESSOR
Pursuant to the Company's lease commitments (see Note 6), funds
provided by the lessor for costs to develop and construct assisted living
residences are used by the Company to pay the related construction costs. The
Company does not have the legal right to offset construction payables against
amounts due from the lessor. Accordingly, receivables due from the lessor
represent construction costs incurred that have not yet been reimbursed by the
lessor.
PROPERTY
Property and equipment are recorded at cost. In connection with the
development of residence projects, the Company has entered into land purchase
contracts, agreements with architects, financing agreements and construction
contracts which are administered by the Company. All costs related to the
development of residences are capitalized during the construction period.
Indirect project development and pre-acquisition costs are allocated to projects
and also are capitalized. Depreciation is computed when assets are placed in
service, using the straight-line method over the respective useful lives of each
class of asset which generally are as follows:
Land improvements.................. 15 years
Buildings.......................... 40 years
Furnishings and equipment.......... 3 - 10 years
Property and equipment consists of the following:
DECEMBER 31,
-----------------------------------------------
1998 1997
---------------------- --------------------
Land and land improvements.................... $ 10,857,263 $ 7,346,278
Buildings..................................... 82,226,796 56,038,464
Furnishings and equipment..................... 9,500,427 7,099,275
Construction-in-progress...................... 18,666,261 49,425,405
---------------------- --------------------
Total.................................... 121,250,747 119,909,422
Accumulated depreciation...................... (4,002,147) (3,926,379)
---------------------- --------------------
Property and equipment - net.................. $ 117,248,600 $ 115,983,043
---------------------- --------------------
---------------------- --------------------
UNUSUAL CHARGES
During the third quarter of 1997, the Company recorded an unusual
charge of approximately $1.4 million which primarily related to a $1.2 million
charge as a result of a decision to abandon
F-8
certain projects. The Company's property and equipment includes costs related to
acquisition and development of projects in process, including capitalized costs
associated with the Company's development department. At the time a project is
abandoned, all previously capitalized costs are expensed. The remaining charges
primarily relate to severance costs associated with third quarter resignations.
ORGANIZATION AND PRE-OPENING COSTS
Organization costs are amortized using the straight-line method over
five years.
Pre-opening costs include costs to hire and train staff, costs to
prepare the residence for operation and other related costs incurred prior to
opening. Costs incurred in connection with preparing the residence for opening
and initial occupancy are capitalized and amortized over one year commencing
with the opening of the residence.
In April 1998, the Accounting Standards Executive Committee issued SOP
98-5, "Reporting on the Costs of Start-Up Activities" which requires that the
costs of start-up activities and organization costs be expensed as incurred. SOP
98-5 is effective for fiscal years beginning after December 15, 1998 with
earlier application encouraged. Management will apply the provisions of the SOP
in the first quarter of 1999. The application of SOP 98-5 will require the
Company to write-off all existing deferred preopening and organization costs
($1.9 million at January 1, 1999) and expense all such items as incurred on a
prospective basis.
DEFERRED FINANCING COSTS
Financing costs are capitalized and amortized using the interest method
over the term of the related financing.
ADVERTISING EXPENSE
The Company records advertising expenditures in accordance with the
provisions of AICPA SOP 93-7, "Reporting on Advertising Costs," which requires
advertising expenditures to be expensed as incurred. Advertising expenditures
were approximately $1,328,000, $709,000 and $424,000 for 1998, 1997 and 1996,
respectively.
INCOME TAXES
Partnership taxable income and losses were allocated to the partners
for inclusion in their respective income tax returns. Accordingly, no provision
or benefit for income taxes was recorded prior to July 18, 1996 (see Note 8).
NET LOSS PER COMMON SHARE
Net loss per common share - basic and diluted for 1998 and 1997 is
computed based on the weighted average number of shares outstanding during the
period as the effect of including any common share equivalents would be
antidilutive. Common share equivalents are comprised of outstanding stock
options. For 1996, the Company had a proforma net loss per share of $0.48. The
proforma net loss per share - basic and diluted for 1996 is computed based on
the weighted average number of shares outstanding during 1996 based on 4,350,000
common shares outstanding following the reorganization (described in Note 9) and
the 2,350,000 common shares issued as a result of the Company's initial public
offering in July 1996.
RECLASSIFICATIONS
Certain 1997 and 1996 balances have been reclassified to conform to the
1998 presentation.
F-9
3. ACQUISITION
On April 30, 1997, the Company completed the acquisition, except for
one entity which was completed on July 1, 1997, of Kensington Management Group,
Inc. and affiliates (Kensington) of Golden Valley, Minnesota. Kensington
operates innovative Alzheimer's care communities under the name Kensington
Cottages which provide Alzheimer's care programs using medical directors with
geriatric and dementia specialties. As of December 31, 1998, Kensington had 12
residences open and four residences complete and being readied to open for a
total of 523 beds in three states.
The aggregate purchase price approximated $28 million, including cash,
the issuance of 137,363 of the Company's common shares, and approximately $22
million in new and assumed bank debt financing. The number of common shares
issued was determined by dividing $1.5 million by the average closing price of
the Company's common shares for the fifteen trading days ending with the third
business day prior to closing. The transaction was accounted for using the
purchase method of accounting. Accordingly, the Company began including the
operating results of Kensington in its consolidated statement of operations
subsequent to April 30, 1997 for seven of the entities and after July 1, 1997
for the remaining entity.
The acquired assets were recorded at fair value based on appraisals.
Assumed liabilities were recorded at the present value of amounts to be paid.
Goodwill related to the acquisition of approximately $8.4 million is being
amortized using the straight-line method over 40 years.
The following unaudited proforma consolidated results of operations for
the years ended December 31, 1997 and 1996 reflect the proforma effects of the
Kensington acquisition as if such transaction had occurred at the beginning of
the years presented below. The unaudited proforma information does not purport
to be indicative of the Company's results of operations that actually would have
occurred had the acquisition of Kensington taken place at the beginning of the
years presented below, or that may be expected to occur in the future.
DECEMBER 31,
--------------------------------------------
1997 1996
-------------------- --------------------
Revenues...................................... $ 21,916,000 $ 16,230,000
Net loss...................................... $ (6,426,000) $ (3,884,000)
Net loss per share -
basic and diluted.......................... $ (0.94) $ (0.70)
4. OTHER ASSETS
Other assets consist of the following:
DECEMBER 31,
---------------------------------------------
1998 1997
--------------------- ------------------
Pre-opening costs, less accumulated
amortization of $1,842,907 and $428,390
at December 31, 1998 and 1997, respectively......... $ 1,799,878 $ 1,194,496
Deferred financing costs, less accumulated
amortization of $319,538 and $225,967
at December 31, 1998 and 1997, respectively......... 2,409,296 1,959,407
Organization costs and other, less accumulated
amortization of $62,148 and $111,506 at
December 31, 1998 and 1997, respectively............ 73,753 113,001
Prepaid rent........................................... -- 2,432,500
Escrow balance (see Note 6)............................ 2,182,824 797,193
Equity in joint ventures (see Note 7).................. (423,582) 384,141
Deposits and other..................................... 337,250 105,986
--------------------- ------------------
$ 6,379,419 $ 6,986,724
--------------------- ------------------
--------------------- ------------------
F-10
5. LEASE COMMITMENTS
The Company has entered into operating lease arrangements expiring in
2010 and 2011 for six residences, five of which opened in 1998. These leases
provide for renewal periods and additional lease payments based on increased
revenues during specified periods. The leases require the Company to maintain
minimum current ratios and net worth requirements and respective residences to
maintain specific debt service coverage ratios. The Company is responsible for
the payment of real estate taxes, site maintenance, and access road maintenance.
In the second quarter of 1998, the Company sold six assisted living
residences for approximately $39.3 million and leased them back under a 20-year
master lease agreement which includes two ten-year renewal options. All six home
leases will be co-terminus and option periods must be exercised for all or none
of the residences. The transaction resulted in a gain of approximately $9.5
million, which was deferred and is being amortized over the initial lease
period. The proceeds of the transaction were used to repay mortgage debt of
$26.4 million and short-term debt of $3.5 million. The balance of the proceeds
was used for development activities and working capital needs.
The Company also leases vehicles and certain office equipment for
periods up to five years and two land only leases that include renewal options
and expire in 2018 and 2026. Future minimum lease payments under noncancellable
operating leases are as follows:
1999.................................... $ 8,378,058
2000.................................... 8,311,514
2001.................................... 8,206,338
2002.................................... 8,074,071
2003.................................... 7,960,365
Thereafter.............................. 85,817,878
--------------
Total................................... $126,748,224
--------------
--------------
Total rental costs incurred were $4,314,000, $423,000 and $221,000 for
the years ended December 31, 1998, 1997 and 1996, respectively.
6. NOTES PAYABLE AND LONG-TERM OBLIGATIONS
Notes payable at December 31, 1998 represent amounts outstanding
under two line of credit arrangements. In March 1997, the Company entered
into a $5 million line of credit expiring in May 1999. At December 31, 1998,
there was $5 million outstanding under this agreement. Interest is payable
monthly and, at the Company's option, accrues at the bank's prime rate or
LIBOR rate plus .75%. Pursuant to the amended merger agreement discussed in
Note 12, Sunrise has made available to the Company a $16.5 million line of
credit to be used for construction and development activities and working
capital which expires in January 2000. Interest is payable monthly and
accrues at 10%. At December 31, 1998, there was $5.3 million outstanding
under this agreement. The weighted average interest rates for short-term
borrowings were 7.3% for 1998 and 7.8% for 1997.
Long-term debt consists of the following:
DECEMBER 31,
-----------------------------------------
1998 1997
------------------- ------------------
$92,155,000 mortgages payable, due from 1999 through 2010; fixed interest rates
range from 9.5% to 10.0% at December 31, 1998; fluctuating interest rates
range from LIBOR plus 2.75% to prime plus 1.25% (8.3% to
9.0% at December 31, 1998)............................................ $ 82,730,970 $ 84,506,399
$5,800,000 residential rental development revenue bonds due in annual
principal payments ranging from $100,000 to $300,000 beginning in 1998
through 2021. Interest is determined weekly (3.5% at December 31, 1998) 5,700,000 5,800,000
$7,500,000 promissory note payable to JMAC, Inc.; interest at prime (7.75%
at December 31, 1998). Balance due in January
F-11
2000 ................................................................. 7,500,000 7,500,000
Other long-term obligations.............................................. 214,272 259,422
------------------- ------------------
Total long-term obligations........................................... 96,145,242 98,065,821
Less current portion..................................................... (392,549) (998,523)
------------------- ------------------
Long term debt, less current portion..................................... $ 95,752,693 $ 97,067,298
------------------- ------------------
------------------- ------------------
The mortgage loans are collateralized by substantially all the assets
of each residence. Certain of the mortgage agreements require the respective
residences to maintain specified debt service coverage ratios and consolidated
minimum current ratios and net worth requirements. Certain lenders also require
escrow balances to be held by the lenders which are included in other assets in
the Company's consolidated balance sheets.
MORTGAGES PAYABLE
Meditrust Mortgage Investments, Inc., an affiliate of Meditrust (a
large health care REIT) provided mortgage and lease financing subject to various
terms and conditions. The financings, which were entered into on a
residence-by-residence basis, are for terms of up to 14 years (with two
additional five-year extension periods for the lease transactions). Interest
during construction accrued at 2% above the prime rate. On completion of each
residence, payments are set at an amount equal to 3.25% over the yield at that
time on the ten-year U.S. Treasury notes. Additional interest or lease payments
are contingent on increased revenues of a financed residence during specified
periods. At December 31, 1998, the Company was in violation of net worth and
current ratio covenants, which the lender has waived through the end of 1999.
The Company has completed mortgage agreements for four residences totaling $22.4
million and six operating lease transactions totaling $46.2 million. The amounts
outstanding under the four mortgage agreements totaled $22.1 million at December
31, 1998. See Note 12.
On April 30, 1997, the Company entered into a $27.6 million promissory
note in conjunction with its acquisition of Kensington (see Note 3) and the
build out of nine Kensington cottages on the Rochester, Minnesota campus.
Interest accrues at 10% and is payable monthly. Principal and interest
installments are payable monthly (based on a 25-year amortization period)
beginning in September 1999 through April 2007 at which time the entire
outstanding principal balance becomes due. The amount outstanding under the
agreement was approximately $19.9 million as of December 31, 1998. The remaining
amounts were to be disbursed in two phases at such time that the nine cottages
and certain other Kensington properties achieved specified debt service coverage
ratios. The Company's decision not to open four of the remaining Rochester
cottages until later in 1999 prevents the Company from accessing $5.9 million of
the remaining $7.7 million of additional funds. The Company is currently in the
process of negotiating an extension that will allow the Company to achieve the
necessary fill-up to meet the required minimum debt service coverage ratios.
In October 1997, the Company entered a $10.3 million construction loan
agreement for the development and construction of three assisted living
residences. Interest is payable monthly and accrues at the bank's prime rate
plus 1 1/2% during construction. In October 1999, the Company may elect, at its
option, to convert the construction loan into a term loan maturing in October
2004. Principal and interest payments under the term loan would be based on a
25-year amortization schedule with interest accruing at either prime plus 1 1/2%
or an amount equal to 3.0% over the yield at the time on five-year U.S. Treasury
notes. The Company is required to maintain minimum net worth and current ratio
amounts and, if the term loan is elected, to maintain debt service coverage
ratios with respect to individual residences. At December 31, 1998, the Company
was in violation of net worth, tangible net worth and current ratio covenants,
which the lender has waived through the end of 1999. As of December 31, 1998,
there was $7.4 million outstanding under this agreement.
In early 1998, the Company entered into two construction loan
agreements totaling $20.1 million. Interest is payable monthly and accrues at
LIBOR plus 2.75% or prime plus 1/2%. The Company is required to maintain minimum
net worth and tangible net worth amounts with respect to one of the loan
agreements ($6.9 million of total). At December 31, 1998, the Company was in
violation of its tangible net worth covenant which the lender has waived through
the end of 1999. In December 2000, the Company may elect, at its option, to
extend the agreements up to two additional
F-12
years. Principal and interest payments under the extension periods would be
based on 25-year amortization schedules with interest accruing at variable
rates. As of December 31, 1998, there was $19.3 million outstanding under these
agreements.
The remaining $14.0 million of mortgages outstanding at December 31,
1998 primarily represent various single facility agreements with various lenders
for seven residences.
REVENUE BOND
In July 1996, the Company entered into a $5.8 million residential
rental development revenue bond with the Allegheny County Industrial Development
Authority. Interest on the bonds is determined weekly, although the Company has
the option to convert the bonds to a term note. While the bonds are in the
weekly rate mode, the bondholders have the option to tender their bonds for
redemption. Any bonds tendered are subject to a remarketing agreement that is
secured by a letter of credit.
PROMISSORY NOTE
In September 1997, the Company entered into a $7.5 million promissory
note with JMAC, Inc., a 33% shareholder of the Company. Interest is payable
monthly and accrues at a bank's prime rate. In addition, the Company has
obtained a commitment from JMAC, Inc. which provides up to $4 million for
working capital needs. Such commitment terminates upon the earlier of the
closing of the Sunrise transaction discussed in Note 12 or January 1, 2000.
Other long-term liabilities primarily represent amounts paid to the
Company by the lessor under certain operating lease agreements. These amounts,
which are not required to be repaid, are deferred and amortized over the term of
the respective leases.
Interest costs incurred were $7,466,000, 5,110,000 and $2,309,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. Of these amounts
$1,583,000, $2,367,000 and $1,038,000 were capitalized to
construction-in-progress in the respective periods. Interest costs incurred
include amounts due under obligations to JMAC and amounted to $660,000, $190,000
and $175,000 in 1998, 1997 and 1996, respectively.
The carrying amounts of long-term obligations approximate fair value as
the interest rates are self-adjusting or are comparable to rates currently
available.
As of December 31, 1998, long-term debt matures as follows:
1999................................. $ 392,549
2000................................. 25,396,935
2001................................. 7,698,754
2002................................. 1,077,590
2003................................. 1,159,643
Thereafter........................... 60,419,771
-----------------
Total................................ $ 96,145,242
-----------------
-----------------
7. INVESTMENT IN UNCONSOLIDATED ENTITIES
The Company and Sisters of Charity Health Care Systems, Inc. of
Cincinnati, Ohio (a founding system of Catholic Health Initiatives ("CHI")),
have entered into six joint venture agreements to develop, own and operate seven
assisted living residences in Ohio, New Mexico and Colorado, six of which were
open at December 31, 1998. Each project is jointly owned by the Company and CHI,
with the Company typically owning approximately 20% of the equity of the
project. Construction and permanent debt financing generally is to be arranged
by CHI on behalf of the venture and is to be non-recourse to the Company. The
Company provides all development and management services with respect to each
residence under a standard agreement that generally provides for a development
fee of $250,000 per project and a management fee of 5% of revenues.
F-13
Under the agreements with CHI, the Company earned and recorded as
revenue development fees of $198,000, $241,000 and $464,000 in 1998, 1997 and
1996, respectively. The Company serves as manager for each of the residences and
receives management fees upon commencement of operations. Management fees of
$501,000, $305,000 and $149,000 have been recorded as revenues for the years
ended December 31, 1998, 1997 and 1996, respectively.
Effective January 1, 1998, the Company entered into a joint venture
agreement with a local hospital to operate an assisted living residence in
Findlay, Ohio, which opened on December 31, 1997. The joint venture paid the
Company a fee of $300,000 for developing the assisted living residence. The
Company has entered into a management agreement with the joint venture which
provides for management fees equal to 6% of revenues. Beginning in the third
year of operations, the Company may earn a 2% incentive management fee if
certain performance criteria are met. The joint venture is owned 50% by the
Company and is accounted for using the equity method of accounting.
As of December 31, 1998, the Company has guaranteed $4.8 million of
joint venture debt financing.
As of December 31, 1998, 1997 and 1996, seven, six and three residences
were open, respectively. Summarized unaudited financial information of
unconsolidated joint ventures is presented below.
DECEMBER 31,
------------------------------------------
1998 1997
------------------- -------------------
BALANCE SHEETS
Current assets.......................... $ 1,392,176 $ 1,269,109
Property................................ 33,229,905 29,140,618
Other assets............................ 402,509 946,972
---------------- ----------------
Total assets....................... $ 35,024,590 $ 31,356,699
---------------- ----------------
---------------- ----------------
Current liabilities..................... $ 2,939,800 $ 1,919,471
Long-term obligations................... 31,002,710 26,662,372
Joint venture equity.................... 1,082,080 2,774,856
---------------- ----------------
Total liabilities and joint
venture equity.............. $ 35,024,590 $ 31,356,699
---------------- ----------------
---------------- ----------------
DECEMBER 31,
------------------------------------------------------------------
1998 1997 1996
------------------- ------------------- --------------------
STATEMENTS OF OPERATIONS
Residence revenues.................. $ 10,596,063 $ 5,468,781 $ 2,347,278
Operating expenses.................. 8,595,135 4,690,309 1,809,886
Depreciation and amortization
expense........................... 1,959,487 979,746 308,589
Interest expense.................... 2,297,849 977,490 436,646
------------------- ------------------- --------------------
Total expenses.................... 12,852,471 6,647,545 2,555,121
------------------- ------------------- --------------------
------------------- ------------------- --------------------
Net loss $ (2,256,408) $ (1,178,764) $ (207,843)
------------------- ------------------- --------------------
------------------- ------------------- --------------------
The Company's equity in net loss of unconsolidated entities included in
its accumulated deficit at December 31, 1998 was approximately $.9 million.
F-14
8. INCOME TAXES
As a partnership, Karrington Operating recorded no provision for income
taxes. Partnership income and losses were allocated to JMAC Properties, Inc. and
Associates for inclusion in their respective income tax returns. As a result of
the reorganization (described in Note 9), the Company applied the provisions of
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" subsequent to July 18, 1996. Deferred income taxes were provided for
differences in the basis for tax purposes and for financial accounting purposes
of recorded assets and liabilities as of July 18, 1996. Accordingly, a tax
provision and a net deferred income tax liability of $938,000 was recorded in
the 1996 balance sheet and statement of operations. The Company recorded a
deferred tax benefit of $255,000 related to its financial reporting loss before
taxes of $625,000 for the period from July 18, 1996 to December 31, 1996.
Significant components of income tax expense for the years ended
December 31, 1998 and 1997 and for the period from July 18, 1996 to December 31,
1996 are as follows:
1998 1997 1996
--------------------- -------------------- --------------------
Current:
Federal................................. $ - $ - $ -
State................................... 340,000 - -
--------------------- -------------------- --------------------
Total current....................... 340,000 - -
--------------------- -------------------- --------------------
Deferred:
Federal................................. (5,056,000) (1,977,000) 580,000
State................................... (893,000) (343,000) 103,000
Increase in valuation allowance......... 5,949,000 2,130,000 -
--------------------- -------------------- --------------------
Total deferred...................... - (190,000) 683,000
--------------------- -------------------- --------------------
Total provision (benefit).................... $ 340,000 $ (190,000) $ 683,000
--------------------- -------------------- --------------------
--------------------- -------------------- --------------------
A reconciliation of the recorded benefit based on the Federal statutory
income tax rate to the Company's income tax provision for 1998, 1997 and the
period from July 18, 1996 to December 31, 1996 is as follows:
1998 1997 1996
------------------ -------------------- -------------------
Benefit at Federal statutory rate.............. (34.0)% (34.0)% (34.0)%
State income taxes, net of Federal
benefit................................... (5.9) (5.9) (5.9)
Nondeductible expenses......................... .6 0.3 0.9
Valuation allowance............................ 39.3 36.4 --
Other.......................................... 2.2 -- (1.8)
------------------ -------------------- -------------------
Effective income tax rate................. 2.2% (3.2)% (40.8)%
------------------ -------------------- -------------------
------------------ -------------------- -------------------
F-15
Deferred income taxes arise from temporary differences between
financial reporting and tax reporting bases of assets and liabilities, and
operating loss carryforwards for tax purposes. The components of the deferred
income tax assets and liabilities are as follows:
DECEMBER 31,
-------------------------------------------
1998 1997
------------------ --------------------
Deferred income tax assets:
Accrued liabilities...................... $323,000 $ 58,000
Deferred gain 3,650,000 --
Asset amortization....................... 726,000 327,000
Operating loss carryforwards............. 4,146,000 2,778,000
Other.................................... 17,000 10,000
------------------ --------------------
Total deferred income tax assets.............. 8,862,000 3,173,000
Valuation allowance........................... (8,079,000) (2,130,000)
------------------ --------------------
Net deferred income tax assets................ 783,000 1,043,000
------------------ --------------------
Deferred income tax liabilities:
Property related......................... (1,220,000) (1,534,000)
Other.................................... (56,000) (2,000)
------------------ --------------------
Total deferred income tax liabilities......... (1,276,000) (1,536,000)
------------------ --------------------
Net deferred income tax liabilities........... $ (493,000) $ (493,000)
------------------ --------------------
------------------ --------------------
Net deferred income tax assets, including net operating loss
carry-forwards, represent the amounts of tax assets that the company could
realize if certain tax planning strategies were employed. The Company's net
operating loss carryforwards of $10.4 million expire from 2011 through 2013.
9. EQUITY
At December 31, 1998, the Company's authorized capital shares consisted
of (a) 28,000,000 common shares, without par value, of which 6,839,368 were
issued and outstanding and (b) 2,000,000 non-voting preferred shares without par
value, none of which has been issued. The Company's Board of Directors has the
authority to issue preferred shares in one or more series and to fix the
designations, the number of shares in such series, liquidation preferences,
dividend rates, conversion rights and redemption provisions of the shares
constituting any series, without any further vote or action by the Company's
shareholders. Any series of preferred shares so issued could have priority over
the common shares with respect to dividend or liquidation rights or both.
On July 18, 1996, 3,000,000 of the Company's common shares were sold
pursuant to its initial public offering. Of the total shares sold, 2,350,000
common shares were sold by the Company and 650,000 common shares were sold by
JMAC. The net proceeds to the Company were approximately $27.5 million of which
$5.7 million was used to repay indebtedness due JMAC. The balance of the net
proceeds was used to finance the development and acquisition of additional
assisted living residences and for working capital and general corporate
purposes.
Immediately prior to July 18, 1996, the shareholders of JMAC
Properties, Inc. and Associates contributed the stock in their respective
companies for stock in the Company. The shareholder of JMAC Properties, Inc.
received 66 2/3% of the pre-offering outstanding common shares of the Company
while the shareholders of Associates received the remaining 33 1/3% (a total of
4,350,000 shares). Following the reorganization, JMAC Properties, Inc. and
Associates became wholly-owned subsidiaries of the Company. As a result, the
Company owned 100% of the equity interests of Karrington Operating.
Effective July 1, 1998, the Company issued 2,005 common shares to
employees pursuant to the 1996 Incentive Stock Plan discussed in Note 10.
F-16
As part of the consideration for the Kensington acquisition
(see Note 3) the Company issued 137,363 common shares on April 30, 1997.
10. INCENTIVE STOCK AND 401(k) PLANS
The Company has adopted the 1996 Incentive Stock Plan (the "Plan"). The
Plan provides for the grant of incentive and non-qualified stock options, stock
appreciation rights, restricted stock, performance shares and unrestricted
common shares. The Plan also provides for the purchase of common shares through
payroll deductions by employees of the Company who have satisfied certain
eligibility requirements. The maximum number of shares available for issuance
under the Plan is 550,000.
The Company has granted non-qualified options to certain officers, key
employees and non-employee directors. The employee options have a ten-year term
with 25% of the options vesting on each of the second through the fifth
anniversaries of the date of grant. Non-employee director options are
exercisable beginning six months after the effective date of grant with a
ten-year term. Each continuing non-employee director will receive on the day
after each annual meeting of shareholders, a grant of a non-qualified stock
option to purchase 2,000 common shares of the Company at an exercise price equal
to the fair market value of the shares on the date of grant.
Stock option activity for 1998, 1997 and 1996 is as follows:
WEIGHTED
AVERAGE RANGE OF
EXERCISE EXERCISE
SHARES PRICE PRICES
------------------ ------------------ -----------------
Balance December 31, 1995............ --
Granted......................... 169,000 $ 13.00 $ 13.00
------------------ ------------------ -----------------
Balance December 31, 1996............ 169,000 13.00 13.00
Granted......................... 215,500 12.25 $ 11.00-12.88
Forfeited....................... (27,000) 13.00 13.00
------------------ ------------------ -----------------
Balance December 31, 1997............ 357,500 12.55 11.00-13.00
Granted......................... 213,000 9.30 9.00-12.50
Forfeited....................... (108,500) 11.09 9.00-13.00
------------------ ------------------ -----------------
Balance December 31, 1998............ 462,000 11.39 $ 9.00-13.00
------------------ ------------------ -----------------
------------------ ------------------ -----------------
At December 31, 1998, the average remaining contractual life was 8.8
years and 176,875 options were exercisable at a weighted average exercise price
of $12.22.
In 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." The
Statement allows for a fair value-based method of accounting for employee stock
options and similar equity instruments. In accordance with the provisions of
SFAS No. 123, the Company has elected to account for options granted under the
Plan in accordance with APB Opinion 25, "Accounting for Stock Issued to
Employees" and related interpretations. If the Company had elected to recognize
compensation cost based on the fair value of options at the grant date as
prescribed by SFAS No. 123, pro forma net loss and pro forma net loss per common
share - basic and diluted for 1998, 1997 and 1996, respectively, would have been
$15,597,000 and $2.28, $5,965,000 and $.88, and $2,914,000 and $.54. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model. The assumptions used in the model for 1998,
1997 and 1996, respectively, included an expected dividend yield of 0%, 0% and
0%; an expected stock price volatility of .53, .47 and .34; a risk-free interest
rate of 4.7%, 6.0% and 6.5%; and an expected life of the options of 7 years, 2
or 7 years, and 10 years. The financial effects of applying SFAS No. 123 are not
likely to be representative of the effects on reported results of operations for
future years.
In 1997, the Company established the Karrington Health, Inc. and
Affiliates 401(k) Plan (the "401(k) Plan") for the benefit of eligible full-time
employees of the Company and its joint ventures.
F-17
Eligible participants may contribute up to 10% of their compensation to the
401(k) Plan and self-direct such contributions. The Company may, in its
discretion, make annual matching and/or discretionary contributions on behalf of
each eligible participant which vest over a six year period. No Company matching
or discretionary contributions were expensed in 1998 or 1997.
11. COMMITMENTS AND CONTINGENCIES
The Company has commitments totaling approximately $3.8 million at
December 31, 1998 for various land purchase contracts and $9.7 million for
various construction contracts.
In the third quarter of 1998, the Company sold two parcels of land in
California for a total of $3.5 million. No gain or loss resulted from this
transaction. The net proceeds to the Company were $2.4 million after paying off
a related note payable of approximately $1.1 million. The parties entered into a
Put and Escrow Agreement related to one of the parcels which states that if the
buyer, after exercise of reasonable diligence, is unable to obtain all final
permits, utility consents and approvals from three governmental agencies on or
before February 1, 1999, the buyer may exercise a "put" to require the Company
to purchase the parcel from the buyer. If the buyer should exercise the put, the
purchase price is $2,100,000 plus one-half (up to a maximum of $25,000) of the
buyer's out-of-pocket costs. As the put had not expired at December 31, 1998,
the Company reported the $2,100,000 purchase price on its balance sheet as "land
sold subject to put right" and "deposit on sale of land." The put was not
exercised and expired on March 1, 1999.
In the ordinary course of business, the Company is threatened with or
named as a defendant in various litigation issues related to its operations. It
is not possible to determine the ultimate disposition of these matters. In the
opinion of management, the outcome of these actions will not significantly
affect the Company's financial position.
12. AGREEMENT OF MERGER AND RELATED AGREEMENTS
On October 18, 1998, the Company and Sunrise Assisted Living, Inc.
("Sunrise"), a provider of assisted living for seniors, entered into a
definitive agreement, as amended March 4, 1999, for Sunrise to acquire the
Company in a tax-free, stock-for-stock transaction valued at approximately $94.9
million.
Under the merger agreement, as amended, the Company would become a
wholly owned subsidiary of Sunrise, and each issued and outstanding share of the
Company's common stock would be automatically converted into the right to
receive 0.3333 shares of Sunrise common stock. Sunrise expects to account for
the acquisition of the Company using the purchase method of accounting.
Pursuant to the amended merger agreement, Sunrise has made available to
the Company a $16.5 million line of credit to be used for construction and
development activities and working capital which expires in January 2000.
After the merger, there will be approximately 21.7 million shares of
Sunrise common stock outstanding. The combined company will operate 115
communities in 19 states with a total resident capacity of approximately 8,746.
It also will have an additional 91 communities in various stages of development.
The acquisition has been approved by the Boards of Directors of both
companies and requires the approval of the shareholders of the Company. The
transaction also is subject to certain other customary conditions, including
regulatory approvals, and is expected to be completed during the second quarter
of 1999.
In December 1998, Sunrise executed an agreement with Meditrust and
acquired four separate first trust mortgages secured by the Company's properties
and the right to purchase six assisted living properties currently leased to the
Company.
Effective January 1, 1999, the Company entered into agreements with
Sunrise to manage the Company's assisted living residences and to develop three
new assisted living properties. These
F-18
agreements were entered into to facilitate the post-merger integration of the
Company's operations. Under the management agreements, Sunrise receives a
management fee of 7% of revenues.
13. RISKS AND UNCERTAINTIES
For the three years ended December 31, 1998, net cash used in
operations totaled $12.6 million. The cash requirement reflects operating losses
associated with newly opened residences and increased general and administrative
costs as part of the Company's rapid growth plan over this period. Cash used by
operations will continue until such time as residences currently in the fill-up
phase become stable and generate enough net profits to absorb losses from
start-up residences.
The Company currently plans to open approximately 16 new Company and
jointly-owned residences in 1999 and the second quarter of 2000. The Company has
existing financing in place in the form of loans or leases for seven of these
residences. Additional financing will be required for the remaining nine
residences, three of which are currently under construction, and to refinance
certain existing indebtedness. The Company has not been pursuing permanent
financing arrangements for the three residences under construction at the
request of Sunrise pending consummation of the proposed merger with Sunrise
described in Note 12. However, the Company continues to evaluate its financing
alternatives, including traditional mortgages and sale/leaseback transactions
which it has been successful in executing in the past.
The Company has been, and will continue to be, dependent on third party
financing for its acquisition and development program. There can be no assurance
that financing for the Company's development program will be available to the
Company on acceptable terms, if at all. Moreover, to the extent the Company
opens properties that do not generate positive cash flow, the Company may be
required to seek additional capital for working capital and liquidity purposes.
Under the amended merger with Sunrise discussed in Note 12, Sunrise has
made available to the Company a $16.5 million line of credit to be used for
construction and development activities and working capital. The line of credit
expires in January 2000.
In March 1999, the Company obtained a commitment from JMAC, Inc. which
provides up to $4 million for working capital needs. Such commitment terminates
upon the earlier of the closing of the Sunrise transaction discussed in Note 12
or January 1, 2000.
The Company believes its existing financing commitments, including the
Sunrise line of credit, together with additional anticipated financing, will be
sufficient to fund its development, construction and working capital needs for
1999.
F-19
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
COL. A COL. B COL. C COL. D COL. E
- ---------------------------------------------------------------------------------------------------------- ------------------
DESCRIPTION BALANCE AT ADDITIONS DEDUCTIONS - BALANCE AT
---------------------------------------
BEGINNING (1) (2) DESCRIBE END
OF PERIOD CHARGED TO CHARGED TO OF PERIOD
COSTS AND OTHER
EXPENSES ACCOUNTS -
DESCRIBE
Reserve for
Terminated Projects
- ----------------------------
YEAR ENDED
----------
December 31, 1998 $30,000 $885,000 - $(655,813) (1) $259,187
------------- ------------- ----------- -------------- -----------
------------- ------------- ----------- -------------- -----------
December 31, 1997 $0 1,191,909 - (1,161,909) (1) $30,000
------------- ------------- ----------- -------------- -----------
------------- ------------- ----------- -------------- -----------
December 31, 1996 $0 - - - $0
------------- ------------- ----------- -------------- -----------
------------- ------------- ----------- -------------- -----------
-------------
(1) The deduction resulted from the Company's decision to abandon
certain projects. At the time a project is abandoned, all previously
capitalized costs are charged against the reserve.
F-20
KARRINGTON HEALTH, INC.
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION REFERENCE
- ------- ----------- ---------
2.1 Stock Purchase Agreement dated April 24, 1997 by and among
Kensington Cottages Corporation of America, Karrington Health,
Inc., Kensington Cottages Corporation of Minnesota and the
individual shareholders of Kensington Cottages Corporation of
Minnesota (2)
2.2 Agreement and Plan of Merger dated April 24, 1997 by and among
Karrington Health, Inc., Kensington Mergeco, Inc., Kensington
Management Group, Inc., and Jon D. Rappaport (2)
2.3 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Buffalo Hills
Residence and Jon D. Rappaport (2)
2.4 Asset Purchase Agreement dated April 24, 1997, by and among Kensington
Cottages Corporation of America, Karrington Health, Inc.,
Centex-Kensington (Mankato I) Partnership, Centex Senior Services
Corporation, Centex Life Solutions, Inc., Kensington Cottages
Corporation of Mankato and Jon D. Rappaport (2)
2.5 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of North Dakota and the individual shareholders of
Kensington Cottages Corporation of North Dakota (2)
2.6 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of Rochester and Jon D. Rappaport (2)
2.7 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Kensington
Cottages Corporation of Iowa and the individual shareholders of
Kensington Cottages Corporation of Iowa (2)
2.8 Asset Purchase Agreement dated April 24, 1997 by and among Kensington
Cottages Corporation of America, Karrington Health, Inc., Bismarck
Investors, Kensington Living Centers, Inc. and Jon D. Rappaport (2)
2.9 Agreement of merger dated October 18, 1998 by and among Karrington
Health, Inc. and Sunrise Assisted Living, Inc. (3)
2.10 Amendment No. 1 to agreement of merger, dated as of March 4, 1999 by
and among Karrington Health, Inc. and Sunrise Assisted Living, Inc. (4)
3.1 Form of Amended Articles of Incorporation of the Company (1)
3.2 Form of Code of Regulations of the Company (1)
10.1 1996 Incentive Stock Plan * (1)
10.4 Registration Rights Agreement dated May 8, 1996, by and among the
Company and the Investors (as defined therein) (1)
10.6 Letter of Intent dated April 29, 1996, by and between the Company and
Sisters of Charity Health Care Systems, Inc. (1)
21 Subsidiaries of the Registrant (6)
23.1 Consent of Ernst & Young LLP (6)
24.1 Power of Attorney - Richard R. Slager (6)
24.2 Power of Attorney - Pete A. Klisares (6)
24.3 Power of Attorney - Mark N. Mace (6)
24.4 Power of Attorney - Charles S. McCreary (6)
24.5 Power of Attorney - John S. Christie (6)
24.6 Power of Attorney - Bernadine P. Healy (6)
24.7 Power of Attorney - David H. Hoag (6)
24.8 Power of Attorney - John H. McConnell (6)
24.9 Power of Attorney - James V. Pickett (6)
24.10 Power of Attorney - Harold A. Poling (6)
24.11 Power of Attorney - Michael H. Thomas (6)
24.12 Power of Attorney - Robert D. Walter (6)
27 Financial Data Schedule (7) (6)
99.1 Option Agreement dated October 18, 1998 by and among Karrington Health,
Inc. and Sunrise Assisted Living, Inc. (5)
99.2 Form of Shareholder Agreement dated October 18, 1998 by and among
Karrington Health, Inc. and Karrington Health, Inc. affiliates, for the
benefit of Sunrise Assisted Living, Inc. (5)
99.3 Safe Harbor Under the Private Securities Litigation Reform Act of 1995 (6)
- -----------------
(1) Included as an exhibit by the same number in the Company's
Registration Statement on Form S-1 (File No. 333-03491) and
incorporated herein by reference.
(3) Included as an exhibit by the same number in the Company's
Form 8-K/A filed on May 21, 1997 and incorporated herein by
reference.
(3) Included as exhibit 2.1 to the Company's report on Form 8K
dated October 30, 1998 and incorporated herein by reference.
(4) Included as exhibit 2.1 to the Company's report on Form 8K
dated March 5, 1998 and incorporated herein by reference.
(5) Included as an exhibit by the same number in the Company's
report on Form 8K dated October 30, 1998 and incorporated
herein by reference.
(6) Filed herewith.
(7) No restated Financial Data Schedules are required to be filed.
* Management contract or compensatory plan or arrangement.