ITEM 1. BUSINESS.
GENERAL
Sunrise Assisted Living, Inc. (the "Company" or "Sunrise") is a leading provider of assisted living services for seniors. The Company currently operates 66 facilities in 13 states with a capacity of approximately 5,750 residents, including 59 facilities owned by the Company or in which it has ownership interests and seven facilities managed for third parties. The Company had revenues of $89.9 million and net income of $4.0 million in 1997. Approximately 99% of the Company's revenues were derived from private pay sources.
The Company's previously announced three-year growth objectives include developing at least 55 new Sunrise model assisted living facilities with an additional resident capacity of more than 4,500 by the end of 1999. To date, the Company has completed development of 27 such facilities with a resident capacity of 2,400 and has 16 facilities currently under construction with a resident capacity of 1,490. The Company has also entered into contracts to purchase 33 additional sites and to lease two additional sites. During 1997, the Company acquired four assisted living and independent living facilities with resident capacity of 274. The Company is pursuing additional development opportunities and also plans to acquire additional facilities as market conditions warrant. See "--Facility Development" and "--Facility Acquisitions."
A subsidiary of the Company has obtained a syndicated revolving credit facility for $250.0 million to be used for general corporate purposes, including the continued construction and development of assisted living facilities. The credit facility is for a term of three years with the right to extend, and is secured by cross-collateralized first mortgages on the real property and improvements and first liens on all assets of the subsidiary. Advances under the facility bear interest at rates from LIBOR plus 1.0% to LIBOR plus 1.5%. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
On June 6, 1997, the Company issued and sold $150.0 million aggregate principal amount of 5 1/2% convertible subordinated notes due 2002 (the "Notes"). The Notes bear interest at 5 1/2% per annum payable semiannually on June 15 and December 15 of each year, beginning December 15, 1997. The conversion price is $37.1875 (equivalent to a conversion rate of 26.89 shares per $1,000 principal amount of the Notes). The Notes are redeemable at the option of the Company commencing June 15, 2000, at specified premiums. The net proceeds to the Company from the sale of the Notes, after deducting underwriting discounts and offering expenses, were approximately $145.6 million. On June 10, 1997, the Company used $57.7 million of the net proceeds to pay down floating rate indebtedness from four financial institutions at a weighted average interest rate of 8.4%. The balance of the net proceeds are being used to fund continued development of new Sunrise model facilities and for possible acquisitions, as well as for working capital and general corporate purposes. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
On June 5, 1996, the Company completed its initial public offering and on October 31, 1996 the Company completed a follow-on public offering. Net proceeds to the Company from these two offerings totaled approximately $196.1 million.
The Company was incorporated in Delaware on December 14, 1994 in order to combine various activities relating to the development, ownership and operation of the Sunrise assisted living facilities held by predecessor entities. The predecessor entities consisted of a management company, a development company, and various entities that held 100% ownership interests in 15 facilities, 50% ownership interests in five facilities and minority ownership interests in two facilities.
THE ASSISTED LIVING INDUSTRY
The Company believes that the assisted living industry is emerging as a preferred alternative to meet the growing demand for a cost-effective setting in which to care for the elderly who do not require the more intensive medical attention provided by a skilled nursing facility but cannot live independently due to physical or cognitive frailties. In general, assisted living represents a combination of housing and 24-hour a day personal support services designed to aid elderly residents with activities of daily living ("ADLs"), such as bathing, eating, personal hygiene, grooming and dressing. Certain assisted living facilities may also provide assistance to residents with low acuity medical needs, or may offer higher levels of personal assistance for incontinent residents or residents with Alzheimer's disease or other forms of dementia. Annual expenditures in the assisted living industry have been estimated to be approximately $12 billion, including facilities ranging from "board and care" to full-service assisted living facilities such as those operated by the Company. The Company believes that consumer preference and demographic trends will allow assisted living to remain one of the fastest growing segments of elder care.
The assisted living industry is highly fragmented and characterized by numerous small operators. The scope of assisted living services varies substantially from one operator to another. Many smaller assisted living providers do not operate in purpose-built facilities, do not have professionally trained staff, and may provide only limited assistance with low-level care activities. The Company believes that few assisted living operators provide a comprehensive range of assisted living services, such as Alzheimer's care and other services designed to permit residents to "age in place" within the facility as they develop further physical or cognitive frailties.
THE SUNRISE OPERATING PHILOSOPHY
The Sunrise approach to assisted living is a unique combination of operating philosophy and a signature facility design. Since the first Sunrise facility opened in 1981, the Company's operating philosophy has been to provide care and services to its residents in a residential environment in a manner that: "nurtures the spirit, protects privacy, fosters individuality, personalizes services, enables freedom of choice, encourages independence, preserves dignity and involves family and friends." The Company believes that its operating philosophy is one of its strengths. Furthermore, in implementing its philosophy, the Company continuously seeks to refine and improve the care and services it offers. The elements of the operating philosophy focus on: the involvement of the resident and the resident's family in important care giving decisions; the Company's proprietary training programs for its management, Administrators and Care Managers; the Company's quality assurance programs; the full range of assisted living services offered by the Company; and the architecture and purpose-built design of Sunrise's "Victorian" model facilities.
SERVICES
The Company offers a full range of assisted living services based upon individual resident needs. Upon admission, the Company, the resident and the resident's family assess the level of care required and jointly develop a specific care plan. This care plan includes selection of resident accommodations and determination of the appropriate level of care. The care plan is periodically reviewed and updated by the Company, the resident and the resident's family. By offering a full range of services, including Basic Care, Assisted Living Plus Care ("Plus Care"), Medication Management and Alzheimer's Care, the Company can accommodate residents with a broad range of service needs and enable residents to age in place. In addition, upon admission the Company generally charges each new resident a one-time community fee typically equal to two months of daily resident fees, which is refundable on a prorated basis if the resident leaves the facility during the first 90 days. Daily resident fees are periodically revised based on increased care or modifications to a resident's care plan.
The average daily resident fee for owned facilities operated by the Company for at least 12 months, or that have achieved stabilization of 95%, was approximately $78 for 1997 and $80 for 1996 and 1995. Excluding acquired facilities, the average daily resident fee was approximately $84 for 1997 and 1996 and $80 for 1995.
BASIC CARE
The Company's Basic Care program is provided to all residents and includes: assistance with ADLs, such as eating, bathing, dressing, personal hygiene, and grooming; three meals per day served in a common dining room (including two seating times per meal); coordination of special diets; 24-hour security; emergency call systems in each unit; transportation to physician offices, stores and community services; assistance with coordination of physician care, physical therapy and other medical services; health promotion and related programs; personal laundry services; housekeeping services; and social and recreational activities.
ASSISTED LIVING PLUS CARE
Through the Company's Plus Care program, residents who require more frequent or intensive assistance or increased care or supervision are provided extra care and supervision. The Company charges an additional daily fee based on additional staff hours of care and services provided. The Plus Care program allows the Company, through consultation with the resident, the resident's family and the resident's personal physician, to create an individualized care and supervision program for residents who might otherwise have to move to a more medically intensive facility. At December 31, 1997, approximately 32% of the Company's assisted living residents participated in the Plus Care program.
MEDICATION MANAGEMENT
Many of the Company's residents also require assistance with medications. To the extent permitted by state law, the Medication Management program includes the storage of medications, the distribution of medications as directed by the resident's physician and compliance monitoring. The Company charges an additional fixed daily fee for this service. At December 31, 1997, approximately 46% of the Company's assisted living residents participated in the Medication Management program.
ALZHEIMER'S CARE
The Company believes its Alzheimer's Care called the Sunrise Reminiscence Program distinguishes it from many other assisted living providers who do not provide such specialized care. The Sunrise Reminiscence Program provides the attention, care programs and services needed to help cognitively impaired residents maintain a higher quality of life. Specially trained staff provide Basic
Care and other specifically designed care and services to cognitively impaired residents in separate areas of facilities. The Company charges each cognitively impaired resident a daily fee that includes one hour of additional staff time per day. Cognitively impaired residents who require additional care and services pay a higher daily rate based on additional staff hours of care and services provided. At December 31, 1997, approximately 21% of the Company's assisted living residents participated in the Sunrise Reminiscence Program.
THE SUNRISE "VICTORIAN" MODEL FACILITY
The Company's signature Victorian model facility, first designed in 1985, is a freestanding, residential-style facility with a capacity of 70 to 110 residents. The building ranges in size from approximately 40,000 to 65,000 square feet and is built generally on sites ranging from two to five acres. Approximately 40% of the building is devoted to common areas and amenities, including reading rooms, family or living rooms and other areas (such as bistros and ice cream parlors) designed to promote interaction among residents. The Company has four basic building plan designs, which provide it with flexibility in adapting the model to a particular site. The building is usually two or three stories and of steel frame construction built to institutional health care standards but strongly residential in appearance. The interior layout is designed to promote a home-like environment, efficient delivery of resident care and resident independence.
Resident units are functionally arranged to provide a "community- within-a-community" atmosphere. The model facility may be configured with as many as eight different types of resident units, including double occupancy units, single units and two- and three-room suites. Sitting areas on each floor serve as a family or living room. The ground level typically contains a kitchen and common dining area, administrative offices, a laundry room, a private dining room, library or living room, and bistro or ice cream parlor. Typically, one floor or one or two wings of a facility contain resident units and common areas, including separate dining facilities, specifically designed to serve residents with Alzheimer's disease or other special needs.
The architectural and interior design concepts incorporate the Sunrise operating philosophy of protecting resident privacy, enabling freedom of choice, encouraging independence and fostering individuality in a homelike setting. The Company believes its model facility meets the desire of many individuals to move to a new residence at least as comfortable as their former home. The Company believes that its residential environments also accomplish several other objectives, including: (i) lessening the trauma of change for elderly residents and their families; (ii) achieving operational efficiencies through proven designs; (iii) facilitating resident mobility and ease of access by care givers; and (iv) differentiating the Company from other assisted living and long-term care operators.
OWNED FACILITIES
The table below sets forth certain information regarding owned facilities or facilities in which Sunrise has an ownership interest that are currently operating as well as those under construction or are subject to purchase contracts and zoned:
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(1) Fifteen of the wholly owned facilities (Oakton, Leesburg, Warrenton, Arlington, Bluemont Park (three facilities), Mercer Island, Fairfax, Frederick, Countryside (two facilities), Gunston, Atrium and Falls Church) serve as collateral for a $86.7 million mortgage loan. Nineteen other wholly owned facilities (Springfield, Morris Plains, Old Tappan, Granite Run, Abington (two facilities), Wayne, Westfields, Decatur, Walnut Creek, Haverford, Huntcliff Summit (assisted living expansion), Lafayette Hill, Oakland Hills, Paramus, Paoli, Fairfield, Smithtown, and Bellevue) serve as collateral for a $250.0 million syndicated revolving credit facility. Sixteen other owned facilities are subject to one or more mortgages or deeds of trust that mature between 1998 and 2033 and bear interest at rates ranging from 6.870% to 9.750% annually as of December 31, 1997. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 6 of Notes to Consolidated Financial Statements. All facilities that are wholly owned by the Company are consolidated in the Consolidated Financial Statements. The Gardner Park and Severna Park facilities are held by limited liability companies or limited partnerships in which the Company holds the ownership interests indicated in the table. The Company is the general partner or managing member of such entities and through the partnership or operating agreements and the management agreements for the facilities the Company controls their ordinary course business operations. Therefore, the Gardner Park and Severna Park facilities are also consolidated in the Consolidated Financial Statements. The ordinary course business operations of the Queen Anne and Towson facilities are not currently controlled by the Company and, therefore, are accounted for under the equity method of accounting.
(2) Each of these facilities has been redeveloped in a manner consistent with the Sunrise model.
(3) Subject to long-term ground lease.
(4) This property is held as a tenancy-in-common. The remaining ownership interests are owned by unaffiliated third parties. The Company manages this facility pursuant to a management contract that is subject to annual renewal at the option of the owners.
(5) These facilities were initially developed by the Company for third parties and were subsequently acquired by the Company in 1992.
(6) This facility is licensed for 40 assisted living residents. The remainder of the resident capacity is for independent living residents.
(7) The remaining ownership interests are owned by third parties. Sunrise manages each of these facilities.
(8) A current officer and a former employee of the Company each have a 25% ownership interest in this facility. Sunrise has the right to acquire these minority ownership interests for fair market value, as determined by an appraiser mutually agreeable to the parties.
(9) This facility is licensed for 24 assisted living residents. The remainder of the resident capacity is for independent living residents. Excludes 12 units owned by the occupants thereof. The occupants can require the Company to repurchase the units for their original purchase prices (aggregating approximately $1.9 million) under certain circumstances. The Company has a right to purchase the units at fair market value upon the happening of certain events and has a right of first refusal on sales of the units.
(10) This facility is licensed for 26 skilled nursing residents. The remainder of the resident capacity is for assisted living residents.
(11) These are not Sunrise model facilities. Sunrise has entered into operating leases with a third-party owner/developer who completed the facilities under a design reviewed and approved by Sunrise. These facilities are operated under 15-year operating leases, with two 10-year extension options.
(12) There can be no assurance that construction delays will not be experienced.
FACILITY DEVELOPMENT
The Company targets sites for development located in major metropolitan areas and their surrounding suburban communities. In evaluating a prospective market, the Company considers a number of factors, including population, income and age demographics, target site visibility, probability of obtaining zoning approvals, estimated level of market demand and the ability to maximize management resources in a specific market by clustering its development and operating activities.
The Company continues to develop its Victorian model facilities in major metropolitan markets. The Company's previously announced three-year growth objectives include developing at least 55 new Sunrise model assisted living facilities with an additional resident capacity of more than 4,500 by the end of 1999. To date, the Company has completed development of 27 such new model facilities with a resident capacity of 2,400 (East Cobb, GA, Fresno, CA, Haverford, PA, Decatur, GA, Walnut Creek, CA, Glen Cove, NY, Ivey Ridge, GA, Cohasset, MA, Denver, CO, Alexandria, VA, Norwood, MA, Wayne, NJ, Wayland, MA, Westfield, NJ, Rockville, MD, Philadelphia, PA (3), Old Tappan, NJ, Morris Plains, NJ, Severna Park, MD (2), Springfield, VA, Oakton, VA, Petaluma, CA, Blue Bell, PA, and Columbia, MD) and has 16 facilities under construction with resident capacity of 1,490. The Company has also entered into contracts to purchase 33 additional sites and to lease two additional sites, and is negotiating purchase terms for the remaining sites. These sites are located in Pennsylvania, Massachusetts, New Jersey, Connecticut, New York, Illinois, California, Missouri, Kansas, and Virginia. The Company is pursuing additional development opportunities as market conditions warrant. Historically, the Company has completed all but one of the facilities for
which it has obtained zoning approval. The Company bases its development upon its "Victorian" model facility that it has developed and refined since the first model facility was designed in 1985. Use of a standard model allows the Company to control development costs, maintain facility consistency and improve operational efficiency. Use of the Sunrise model also creates "brand" awareness in the Company's markets.
The primary milestones in the development process are (i) site selection and contract signing, (ii) zoning and site plan approval and (iii) completion of construction. Once a market has been identified, site selection and contract signing typically take approximately one to three months. Zoning and site plan approval generally take 10 to 12 months and are typically the most difficult steps in the development process due to the Company's selection of sites in established communities which usually require site rezoning. Facility construction normally takes 10 to 12 months. The Company believes its extensive development experience gives it an advantage relative to certain of its competitors in obtaining necessary governmental approvals and completing construction in a timely manner. After a facility receives a certificate of occupancy, residents usually begin to move in within one month. Since 1993, the total capitalized cost to develop, construct and open a Sunrise model facility, including land acquisition and construction costs, has ranged from approximately $8.5 million to $12.0 million. The cost of any particular facility may vary considerably based on a variety of site-specific factors.
The Company's development activities are coordinated by its experienced 30-person development staff, which has extensive real estate acquisition, engineering, general construction and project management experience. Architectural design and hands-on construction functions are usually contracted to experienced outside architects and contractors.
The Company's ability to achieve its development plans will depend upon a variety of factors, many of which are beyond the Company's control. There can be no assurance that the Company will not suffer delays in its development program, which could slow the Company's growth. The successful development of additional assisted living facilities will involve a number of risks, including the possibility that the Company may be unable to locate suitable sites at acceptable prices or may be unable to obtain, or may experience delays in obtaining, necessary zoning, land use, building, occupancy, licensing and other required governmental permits and authorizations. The Company may also incur construction costs that exceed original estimates, may not complete construction projects on schedule and may experience competition in the search for suitable development sites. The Company relies on third-party general contractors to construct its new assisted living facilities. There can be no assurance that the Company will not experience difficulties in working with general contractors and subcontractors, which could result in increased construction costs and delays. Further, facility development is subject to a number of contingencies over which the Company will have little control and that may adversely affect project cost and completion time, including shortages of, or the inability to obtain, labor or materials, the inability of the general contractor or subcontractors to perform under their contracts, strikes, adverse weather conditions and changes in applicable laws or regulations or in the method of applying such laws and regulations. Accordingly, if the Company is unable to achieve its development plans, its business, financial condition and results of operations could be adversely affected.
FACILITY ACQUISITIONS
The Company's previously announced growth plan included the acquisition of up to 15 facilities by the end of 1999, of which nine have been acquired. In evaluating possible acquisitions, the Company considers, among other factors, (i) location, construction quality, condition and design of the facility, (ii) current and projected facility cash flow, (iii) the ability to increase revenue, occupancy and cash flow by
providing a full range of assisted living services, (iv) costs of facility repositioning (including renovations, if any) and (v) the extent to which the acquisition will complement the Company's development plans.
There can be no assurance that the Company's acquisition of assisted living facilities will be completed at the rate currently expected, if at all. The success of the Company's acquisitions will be determined by numerous factors, including the Company's ability to identify suitable acquisition candidates, competition for such acquisitions, the purchase price, the financial performance of the facilities after acquisition and the ability of the Company to integrate effectively the operations of acquired facilities. Any failure by the Company to integrate or operate acquired facilities effectively may have a material adverse effect on the Company's business, financial condition and results of operations.
NEED FOR ADDITIONAL FINANCING
To achieve its growth objectives, the Company will need to obtain substantial additional resources to fund its development, construction and acquisition activities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation." The Company expects that the number of owned and operated facilities will increase substantially as it pursues its development and acquisition programs for new assisted living facilities. This rapid growth will place significant demands on the Company's management resources. The Company's ability to manage its growth effectively will require it to continue to expand its operational, financial and management information systems and to continue to attract, train, motivate, manage and retain key employees. If the Company is unable to manage its growth effectively, its business, financial condition and results of operations could be adversely affected.
MANAGED FACILITIES
The Company also manages for third-party owners seven operating facilities and one facility under construction with total resident capacity of 756, including, four in Massachusetts, two in New Jersey, one in Pennsylvania, and one in Virginia. The two facilities in New Jersey are Sunrise model facilities. The management contract expiration dates range from October 1998 to January 2002. The Company owns $5.4 million carrying value of tax exempt mortgage bonds on the Pennsylvania facility. One of the Massachusetts facilities is licensed for 139 continuing care retirement community residents. Pursuant to the management agreement with one of the New Jersey facilities, the company has a right of first refusal to purchase the facility if the owner receives a bona fide offer to purchase the facility during the term of the management agreement. The Company does not provide financial or accounting services to the Virginia facility.
The Company also manages two skilled nursing facilities, Pembrook and Prospect Park, located in West Chester and Prospect Park, Pennsylvania, respectively. The Pembrook facility has 240 beds and the Prospect Park facility has 180 beds. Both of these facilities are owned by a single unaffiliated nonprofit corporation. The management contracts for these facilities were initially entered into in May 1994 and expire in April 1999. The Company received management fee revenues of approximately $0.4 million in 1997 for these two facilities. The Company is entitled to receive a deferred management fee of approximately $0.7 million, as of December 31, 1997, if the owners terminate the management agreement or sell the properties. The Company does not provide financial or accounting services for these facilities.
COMPANY OPERATIONS
OPERATING STRUCTURE
The Company has centralized accounting, finance and other operational functions at the corporate headquarters and regional office levels in order to allow facility-based personnel to focus on resident care, consistent with the Company's operating philosophy. Headquarters staff members in Fairfax, Virginia are responsible for: the establishment of Company-wide policies and procedures relating to, among other things, resident care, facility design and facility operations; billing and collection; accounts payable; finance and accounting; management of the Company's development and acquisition activities; development of employee training materials and programs; and providing overall strategic direction to the Company. Regional staff are responsible for: overseeing all aspects of facility-based operations, including marketing activities; resident care; the hiring of Administrators, Care Managers and other facility-based personnel; compliance with applicable local and state regulatory requirements; and implementation of the Company's development and acquisition plans within a given geographic region.
The Company is currently organized into several regions. Each of the regions is headed by a Regional Senior Vice President or Vice President with extensive experience in the long-term care and assisted living industries. The regional staff typically consists of a Marketing Specialist, a Resident Care Specialist and a Human Resources Specialist. The Company's largest region also has separate Marketing Specialists for existing facilities and those in development, an Activities Specialist, a Regulatory Specialist, a Dietary Specialist and a Maintenance Specialist. The Company expects that all regions will create similar staff positions as the number of facilities in those regions increases.
FACILITY STAFFING
Each of the Company's facilities has an Administrator responsible for the day-to-day operations of the facility, including quality of care, social services and financial performance. Each Administrator receives specialized training from the Company. The Company believes that the quality and size of its facilities, coupled with its competitive compensation philosophy, have enabled it to attract high-quality, professional Administrators. The Administrator is supported by the Director of Resident Care, a nurse who oversees the Care Managers and is directly responsible for day-to-day care of the residents, and by the Director of Community Relations, who oversees marketing and outreach programs. Other key positions include the Director of Dining Services, the Activities Director, and in certain homes, the Director of Alzheimer's Care.
Care Managers, who work on full-time, part-time and flex-time schedules, provide most of the hands-on resident care, such as bathing, dressing and other personalized care services (including housekeeping, meal service and resident activities). To the extent permitted by state law, nurses, or Care Managers who complete a special training program, supervise the storage and distribution of medications. The use of Care Managers to provide substantially all services to residents has the benefits of consistency and continuity in resident care. In most cases, the same Care Manager assists the resident in dressing, dining and coordinating daily activities. The number of Care Managers working in a facility varies according to the level of care required by the residents of the facility and the numbers of residents receiving Alzheimer's Care and Plus Care services. The number of Care Managers ranges from three (Leesburg facility) to 20 (Atrium facility) on the day shifts and from two Care Managers (Leesburg) to seven Care Managers (Atrium) on the night shift.
The Company believes that its facilities can be most efficiently managed by maximizing direct resident and staff contact. Employees involved in resident care, including the administrative staff, are trained in the Care Manager duties and participate in supporting the care needs of the residents. Accounting functions are centralized so that administrative staff may devote substantially all of their time to care giving.
The Company has attracted, and continues to seek, highly dedicated, experienced personnel. The Company has adopted formal training procedures and review and evaluation procedures to help ensure quality care for its residents. The Company believes that education, training and development enhance the effectiveness of its employees. All employees are required to complete the Company's training program, which centers around its proprietary "Five-Star Educational Program." This program includes a core curriculum consisting of care basics, Alzheimer's care, resident care procedures and communication skills. For Care Managers who desire to advance into facility management, the Five-Star Education Program provides additional training in medical awareness and management skills. There are also leadership certifications in areas such as community relations, facility management, recruiting, staffing, human resources and regulations. Sunrise also has developed an "Administrator-in-Training ("AIT") Program" that places an Administrator trainee in an existing facility to learn the position based on hands-on experience and direct supervision from a current Administrator. The AIT Program is intended to ensure that enough Sunrise-trained professionals will be available to manage acquired and newly developed facilities.
QUALITY ASSURANCE
The Company coordinates quality assurance programs at each of its facilities through its corporate headquarters staff and through its regional offices. The Company's commitment to quality assurance is designed to achieve a high degree of resident and family member satisfaction with the care and services provided by the Company. In addition to ongoing training and performance reviews of Care Managers and other employees, the Company's quality control measures include:
Family and Resident Feedback. The Company surveys residents and family members on a regular basis to monitor the quality of services provided to residents. Approximately 30 days after moving into a facility, a resident or family member is surveyed by a Sunrise representative to inquire about their initial level of satisfaction. Thereafter, annual written surveys are used to appraise and monitor the level of satisfaction of residents and their families. A toll-free telephone line also is maintained which may be used at any time by a resident's family members to convey comments.
Regular Facility Inspections. Facility inspections are conducted by regional vice presidents and other regional staff on at least a monthly basis. These inspections cover: the appearance of the exterior and grounds; the appearance and cleanliness of the interior; the professionalism and friendliness of staff; resident care plans; the quality of activities and the dining program; observance of residents in their daily living activities; and compliance with government regulations.
Third-Party Reviews. To further evaluate customer service, the Company engages an independent service evaluation company to "mystery shop" the Company's facilities. These professionals assess the Company's performance from the perspective of a customer, without the inherent biases of a Company employee. Each facility is "shopped" at least three times per year in person, as well as one or more times per month by telephone. To evaluate medication management, third-party pharmacists conduct periodic reviews of on-site handling and storage of medications, record-keeping and coordination of medications.
MARKETING AND SALES
The Company's marketing strategy is intended to create awareness of the Company and its services among potential residents and their family members and referral sources, such as hospital discharge planners, physicians, clergy, area agencies for the elderly, skilled nursing facilities, home health agencies and social workers. A central marketing staff develops overall strategies for promoting the Company throughout its markets and monitors the success of the Company's marketing efforts. Each regional office generally has at least one Marketing Specialist and each facility typically has a Director of Community Relations who oversees marketing and outreach programs. In addition to direct contacts
with prospective referral sources, the Company also relies on print advertising, yellow pages advertising, direct mail, signage and special events, such as grand openings for new facilities, health fairs and community receptions.
THIRD-PARTY RESIDENT SERVICES
While the Company serves the vast majority of a resident's needs with its own staff, certain services, such as physician care, infusion therapy, physical and speech therapy and other home health care services, may be provided to residents at Sunrise facilities by third parties. Company staff assist residents in locating qualified providers for such health care services. In October 1996, the Company entered into an affiliation agreement with Jefferson Health System ("JHS"), an integrated health care system located in Philadelphia, Pennsylvania, pursuant to which JHS has agreed to provide residents of Sunrise facilities located in the Philadelphia metropolitan region, on a preferred (but non-exclusive) basis, with access to certain health care services offered by JHS. Such health care services may include hospital services, physician services, rehabilitation services, home health services and products and mental health services.
COMPETITION
The long-term care industry is highly competitive and the Company believes that the assisted living segment, in particular, will become even more competitive in the future. The Company will be competing with numerous other companies providing similar long-term care alternatives such as home health care agencies, facility-based service programs, retirement communities and convalescent centers. In general, regulatory and other barriers to competitive entry in the assisted living industry are not substantial. In pursuing its growth strategy, the Company expects to face competition in its efforts to develop and acquire assisted living facilities. Some of the Company's present and potential competitors are significantly larger and have, or may obtain, greater financial resources than the Company. Consequently, there can be no assurance that the Company will not encounter increased competition that could limit its ability to attract residents or expand its business and that could have a material adverse effect on its business, financial condition and results of operations. Moreover, if the development of new assisted living facilities outpaces demand for those facilities in certain markets, such markets may become saturated. Such an oversupply of facilities could cause the Company to experience decreased occupancy, depressed margins and lower operating results. Providers of assisted living and related services compete for residents primarily on the basis of quality of care, price, reputation, physical appearance of the facilities, services offered, family and physician preferences and location. As assisted living receives increased attention, the Company believes that competition will grow from new local and regional companies that operate, manage and develop assisted living facilities within the same geographic areas as the Company.
STAFFING AND LABOR COSTS
The Company competes with various health care services providers, including other elderly care providers, in attracting and retaining qualified or skilled personnel. A shortage of nurses or other trained personnel or general inflationary pressures may require the Company to enhance its wage and benefits package to compete effectively for personnel. The Company's general and administrative expenses (which consist primarily of staffing and labor expenses, including hiring additional staff and increasing the salary and benefits of existing staff) as a percentage of operating revenue were 11.6% for 1997, 21.2% for 1996, and 18.5% for 1995. The reduction of general and administrative expenses as a percentage of operating revenue decreased in 1997 as compared to 1996 primarily because operating revenue increased at a much faster rate than general and administrative expenses. There can be no assurance that the Company's labor costs will not increase as a percentage of operating revenue. Any significant failure by the Company to attract and retain qualified employees, to control its labor costs or
STAFF EDUCATION AND TRAINING
to match increases in its labor expenses with corresponding increases in revenues could have a material adverse effect on the Company's business, financial condition and results of operations.
GOVERNMENT REGULATION
The Company's facilities are subject to regulation and licensing by state and local health and social service agencies and other regulatory authorities, although requirements vary from state to state. In general, these requirements address, among other things: personnel education, training, and records; facility services, including administration of medication, assistance with self-administration of medication, and limited nursing services; monitoring of resident wellness; physical plant specifications; furnishing of resident units; food and housekeeping services; emergency evacuation plans; and resident rights and responsibilities, including in some states the right to receive certain health care services from providers of a resident's choice. Certain of the Company's facilities are also licensed to provide independent living services which generally involve lower levels of resident assistance. In several states in which the Company operates or intends to operate, assisted living facilities also require a certificate of need before the facility can be opened. In most states, assisted living facilities also are subject to state or local building code, fire code and food service licensure or certification requirements. Like other health care facilities, assisted living facilities are subject to periodic survey or inspection by governmental authorities. From time to time in the ordinary course of business, the Company receives deficiency reports. The Company reviews such reports and seeks to take appropriate corrective action. Although most inspection deficiencies are resolved through a plan of correction, the reviewing agency typically is authorized to take action against a licensed facility where deficiencies are noted in the inspection 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.
Any failure by the Company to comply with applicable requirements could have a material and adverse effect on the Company's business, financial condition and results of operations. Regulation of the assisted living industry is evolving and the Company's operations could also be adversely affected by, among other things, future regulatory developments such as mandatory increases in scope and quality of care to be afforded residents and revisions to licensing and certification standards. Increased regulatory requirements could increase costs of compliance with such requirements.
The Company also is subject to Federal and state anti-remuneration laws, such as the Medicare/ Medicaid anti-kickback law which govern certain financial arrangements among health care providers and others who may be in a position to refer or recommend patients to such providers. These laws prohibit, among other things, certain direct and indirect payments that are intended to induce the referral of patients to, the arranging for services by, or the recommending of, a particular provider of health care items or services. The Medicare/Medicaid anti-kickback law has been broadly interpreted to apply to certain contractual relationships between health care providers and sources of patient referral. Similar state laws vary from state to state, are sometimes vague and seldom have been interpreted by courts or regulatory agencies. Violation of these laws can result in loss of licensure, civil and criminal penalties, and exclusion of health care providers or suppliers from participation in (i.e., furnishing covered items or services to beneficiaries of) the Medicare and Medicaid programs. There can be no assurance that such laws will be interpreted in a manner consistent with the practices of the Company.
Management is not aware of any non-compliance by the Company with applicable regulatory requirements that would have a material adverse effect on the Company's financial condition or results of operations.
ENVIRONMENTAL RISKS
Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be held liable for the cost of removal or remediation of certain hazardous or toxic substances, including, without limitation, asbestos-containing materials, that could be located on, in or under such property. Such laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances. The costs of any required remediation or removal of these substances could be substantial and the liability of an owner or operator as to any property is generally not limited under such laws and regulations and could exceed the property's value and the aggregate assets of the owner or operator. The presence of these substances or failure to remediate such substances properly may also adversely affect the owner's ability to sell or rent the property, or to borrow using the property as collateral. Under these laws and regulations, an owner, operator or an entity that arranges for the disposal of hazardous or toxic substances, such as asbestos-containing materials, at a disposal site may also be liable for the costs of any required remediation or removal of the hazardous or toxic substances at the disposal site. In connection with the ownership or operation of its properties, the Company could be liable for these costs, as well as certain other costs, including governmental fines and injuries to persons or properties. As a result, the presence, with or without the Company's knowledge, of hazardous or toxic substances at any property held or operated by the Company, or acquired or operated by the Company in the future, could have an adverse effect on the Company's business, financial condition and results of operations. Environmental audits performed on the Company's properties have not revealed any significant environmental liability that management believes would have a material adverse effect on the Company's business, financial condition or results of operations. No assurance can be given that existing environmental audits with respect to any of the Company's properties reveal all environmental liabilities.
LIABILITY AND INSURANCE
The Company's business entails an inherent risk of liability. In recent years, participants in the long-term care industry, including the Company, have become subject to an increasing number of lawsuits alleging negligence or related legal theories, many of which involve large claims and significant legal costs. The Company is from time to time subject to such suits as a result of the nature of its business. The Company currently maintains insurance policies in amounts and with such coverage and deductibles as it believes are adequate, based on the nature and risks of its business, historical experience and industry standards. The Company also currently maintains professional liability insurance and general liability insurance. The Company's medical professional liability coverage is limited to $1,000,000 per occurrence and $3,000,000 in the aggregate for all claims per annual policy period. The non-medical professional liability insurance coverage is limited to $5,000,000 per wrongful act and $7,000,000 in the aggregate. The general liability insurance is limited to $1,000,000 per facility/per event, with additional specific limitations of $100,000 per event (premises damage), $5,000 per event (medical expenses) and $1,000 per event (resident's property damage). The Company also has an umbrella excess liability protection policy in the total amount of $25,000,000. There can be no assurance that claims will not arise which are in excess of the Company's insurance coverage or are not covered by the Company's insurance coverage. A successful claim against the Company not covered by, or in excess of, the Company's insurance could have a material adverse effect on the Company's financial condition and results of operations. Claims against the Company, regardless of their merit or eventual outcome, may also have a material adverse effect on the Company's ability to attract residents or expand its business and would require management to devote time to matters unrelated to the operation of the Company's business. In addition, the Company's insurance policies must be renewed annually and there can be no assurance that the Company will be able to continue to obtain liability insurance coverage in the future or, if available, that such coverage will be available on acceptable terms.
EMPLOYEES
At December 31, 1997, the Company had 3,377 employees, including 2,060 full-time employees, of which 105 were employed at the Company's headquarters. The Company believes employee relations are good.
ITEM 2.
ITEM 2. PROPERTIES.
The Company leases its corporate office, regional offices, and warehouse space under various leases. The leases have terms of five to seven years. The corporate lease has an option to terminate after twelve months from the most recent expansion commencement. The initial annual lease payments of the corporate leases amount to $258,000, and the base rent is subject to annual increases based on the Consumer Price Index from a minimum of 2% to a maximum cap of 3% per year. The initial annual base rent payments under the warehouse lease amount to $148,000. Various other leases expire during 1998 and 1999.
The Company also has entered into operating leases for five facilities and three long-term ground leases related to other facilities. The operating lease terms vary from fifteen years, with two ten-year extension options. The ground leases have terms of seventy-five years to ninety-nine years. For information regarding facilities owned by the Company or in which it holds interests, see "Item 1. Business -- Owned Facilities" and "-- Facility Development."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in various lawsuits and claims arising in the normal course of business. In the opinion of management of the Company, although the outcomes of these suits and claims are uncertain, in the aggregate they should not have a material adverse effect on the Company's business, financial condition and results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the Nasdaq National Market under the symbol "SNRZ." Other information set forth under the caption "Corporate Information" on page 40 of the Company's 1997 Annual Report to Stockholders is incorporated by reference herein.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The information set forth under the caption "Selected Financial and Operating Data" on page 17 of the Company's 1997 Annual Report to Stockholders is incorporated by reference herein.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 18 to 24 of the Company's 1997 Annual Report to Stockholders is incorporated by reference herein.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements set forth on pages 26 to 37 of the Company's 1997 Annual Report to Stockholders are incorporated by reference herein.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the captions "Election of Directors - -- Information as to Nominees and Other Directors," "-- Other Executive Officers," and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's 1998 Annual Meeting Proxy Statement, which the Company intends to file within 120 days after its fiscal year-end, is incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the captions "Compensation of Directors" and "Executive Compensation and Other Information" in the Company's 1998 Annual Meeting Proxy Statement, which the Company intends to file within 120 days after its fiscal year-end, is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the captions "Stock Owned by Management" and "Principal Holders of Voting Securities" in the Company's 1998 Annual Meeting Proxy Statement, which the Company intends to file within 120 days after its fiscal year-end, is incorporated by reference herein.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Certain Transactions" in the Company's 1998 Annual Meeting Proxy Statement, which the Company intends to file within 120 days after its fiscal year-end, is incorporated by reference herein.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of Form 10-K.
(1) Financial Statements:
Consolidated Balance Sheets -- December 31, 1997 and 1996.
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Changes in Stockholders' (Deficit) Equity.
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
Report of Independent Auditors.
The remaining information appearing in the Company's 1997 Annual Report to Stockholders is not deemed to be filed as part of this Report, except as expressly provided herein.
(2) Financial Statements Schedules:
All 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 or are included in the consolidated financial statements.
(3) Exhibits:
The Exhibits filed as part of this Annual Report on Form 10-K are listed on the Index to Exhibits on pages 23 to 28 and are incorporated by reference herein.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
The Company hereby files as part of this Annual Report on Form 10-K the Exhibits listed in the Index to Exhibits.
(d) Financial Statement Schedules.
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUNRISE ASSISTED LIVING, INC. ------------------------------------------ Registrant
By: /s/ Paul J. Klaassen --------------------------------------- Paul J. Klaassen Chairman of the Board and Chief Executive Officer
3/26/98 --------------------------------------- Date
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS