ITEM 1. BUSINESS
GENERAL
LTC Healthcare, Inc. (the "Company"), a Nevada corporation, was incorporated on March 20, 1998 and began operations on March 25, 1998 to engage in the following activities: (i) ownership of leveraged properties leased to third parties; (ii) ownership of secured high yield mortgage loans; (iii) operation of long-term care facilities; (iv) development of long-term care properties, and (v) ownership of equity investments in long-term care companies. The Company was originally a preferred stock subsidiary of LTC Properties, Inc. ("LTC"), a Maryland corporation and real estate investment trust ("REIT"). On September 30, 1998, concurrently with the conversion of all shares of Company non-voting common stock held by LTC into voting common stock of the Company, LTC completed the spin-off of Company common stock through a taxable dividend to holders of LTC common stock, convertible subordinated debentures and Series C Preferred Stock (the "Distribution"). Upon completion of the Distribution, the Company began operating as a separate public company.
The Company was organized to create and realize value by identifying and making opportunistic real estate and health care investments through the direct acquisition, development, financing and operation of real properties and/or participation in these activities through the purchase of debt instruments or equity interests of entities engaged in the health care or real estate businesses. The Company will endeavor to provide investors with return opportunities that are not generally available to publicly traded REITs due to investment limitations and leverage expectations imposed by the public markets and Federal income tax laws applicable to REITs. See "Item 2.
ITEM 2. PROPERTIES
REAL ESTATE INVESTMENTS
As of December 31, 1998, the Company's real estate investment portfolio contained 13 properties consisting of seven skilled nursing facilities ("SNFs") with a total of 914 beds, five assisted living residences ("ALFs") with a total of 293 units and one Alzheimer facility with 26 units, representing a net investment of $65,182,000 (before accumulated depreciation of $4,306,000). All of the above real estate properties were contributed to the Company by LTC in connection with the Distribution.
Skilled nursing facilities provide restorative, rehabilitative and nursing care for people not requiring the more extensive and sophisticated treatment available at acute care hospitals. Many skilled nursing facilities provide ancillary services that include occupational, speech, physical, respiratory and IV therapies, as well as provide sub-acute care services. Such services are paid either by the patient or the patient's family, or through the federal Medicare or state Medicaid programs. Assisted living facilities serve elderly persons who require assistance with activities of daily living, but do not require the constant supervision skilled nursing facilities provide. Services are generally available 24-hours a day and include personal supervision and assistance with eating, bathing, grooming and administering medication. The facilities provide a combination of housing, supportive services, personalized assistance and health care designed to respond to individual needs.
The following table sets forth certain information regarding the Company's owned properties as of December 31, 1998:
(1) Encumbrances consist of non-recourse mortgages payable by the Company secured by first mortgages on the facilities.
(2) Consists of: SNFs-$25,882,000; ALFs-$36,010,000; and Alzheimer facility-$3,290,000.
The leases generally have an initial term of ten to twelve years and provide for a fixed minimum base rent during the initial and renewal periods. Most of the leases provide for annual fixed rent increases or increases based on increases in consumer price indices over the term of the lease. In addition, certain of the Company's leases provide for additional rent through revenue participation (as defined in the lease agreement) in incremental revenues generated by the facilities, over a defined base period, effective at various times during the term of the lease. Each lease is a triple net lease which requires the lessee to pay additional charges including all taxes, insurance, assessments, maintenance and repair (capital and non-capital expenditures), and other costs necessary in the operation of the facility.
INVESTMENTS IN DEBT AND EQUITY SECURITIES
At December 31, 1998 the Company owned the following debt and equity securities:
- - $8,500,000 principal amount of Regent Assisted Living, Inc. 7.5% convertible subordinated debentures due 2008 (fair value approximates face value);
- - $3,000,000 principal amount (amortized cost of $2,191,000) of Assisted Living Concepts, Inc. 5.625% convertible subordinated debentures due 2003 (fair value of $2,386,000);
- - 30,847 shares of Assisted Living Concepts, Inc. common stock contributed by LTC in connection with its distribution of its investment in the Company with a fair value of approximately $405,000 (net of the fair market adjustment of approximately $81,000); and
- - 194,100 shares of LTC common stock acquired for an aggregate purchase price of $3,308,000 (fair value of $3,227,000).
MAJOR OPERATORS
As of December 31, 1998, Integrated Health Services, Inc. ("IHS"), Sun Healthcare Group, Inc., through a wholly owned subsidiary, ("Sun") and Karrington Health, Inc. ("Karrington") were the Company's largest operators. As of December 31, 1998, approximately 11%, 25% and 60% of the Company's gross real estate investments were leased to IHS, Sun and Karrington, respectively. In addition, the Company's investment of $8,500,000 in Regent Assisted Living, Inc. ("Regent") convertible debentures represented approximately 11% of the Company's total assets as of December 31, 1998. IHS, Sun, Karrington and Regent are publicly traded companies, and as such are subject to the filing requirements of the Securities and Exchange Commission. See "Item 8. -Financial Statements -Note 2. Summary of Significant Accounting Policies -CONCENTRATION OF CREDIT RISKS." for summary information for IHS, Sun, Karrington and Regent that was extracted from public reports on file with the Securities and Exchange Commission.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any legal proceeding which, in the opinion of management, would be material to its' results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS
Mr. Dimitriadis has served as Chairman and CEO of the Company since its inception. He founded LTC in 1992 and was employed by Beverly Enterprises, Inc., an owner/operator of long-term care facilities, retirement living facilities and pharmacies, from October 1989 to May 1992, where he served as Executive Vice President and Chief Financial Officer. Prior to that, he was employed by American Medical International, Inc., an owner/operator of hospitals, from 1985 to 1989, where he served as Executive Vice President - Finance, Chief Financial Officer and Director. Mr. Dimitriadis is a member of the board of Magellan Health Services.
Mr. Pieczynski has served as President and Director of the Company since its inception. He has also served as President and Director of LTC since September 8, 1997 and Chief Financial Officer of LTC since May 1994. From May 1994 to September 1997, he also served as Senior Vice President of LTC. He joined LTC in December 1993 as Vice President and Treasurer. Prior to that, he was employed by American Medical International, Inc., an owner/operator of hospitals, from May 1990 to December 1993, where he served as Assistant Controller and Director of Development.
Mr. Ishikawa has served as Senior Vice President and Chief Investment Officer of the Company since its inception. He has also served as Senior Vice President and Chief Investment Officer of LTC since September 8, 1997. Prior to that, he served as the Vice President and Treasurer of LTC since April 1995. Prior to joining LTC, he was employed by MetroBank from December 1991 to March 1995, where he served as First Vice President and Controller. From December 1989 to November 1991, he was employed by Mercantile National Bank where he served as Assistant Treasurer.
Mr. Shawaf has served as Senior Vice President and General Counsel of the Company and LTC since March 1, 1999. From September 1997 to March 1999, he served as Vice President and Assistant General Counsel of LTC. Prior to joining LTC, he was employed by Pamela J. Privett, A Professional Law Corporation, which served outside General Counsel to LTC from June 1997 to September 1997. From November 1996 to June 1997, he was the sole owner of Raad K. Shawaf , Attorney At Law, a real estate law practice. From June 1993 to June 1996, he was an associate attorney at Stern, Neubauer, Greenwald & Pauly.
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) The Company's common stock is listed on the Pacific Exchange and began active trading on October 1, 1998. Set forth below are the high and low reported sale prices for the Company's common stock as reported on the Pacific Exchange.
(b) As of December 31, 1998, there were approximately 802 stockholders of record of the Company's common stock.
(c) The Company has never paid cash dividends on its common stock. The Company currently anticipates that it will retain all available funds for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL INFORMATION
The Company was not formed until March 25, 1998 therefore, comparative results with 1997 are not provided. The following table summarizes the Company's results of operations for the period from inception (March 25, 1998) through December 31, 1998 and balance sheet information as of December 31, 1998 and should be read in conjunction with the Company's financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K (Dollars in thousands except share amounts).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OPERATING RESULTS FOR THE PERIOD FROM INCEPTION (MARCH 25, 1998) THROUGH DECEMBER 31, 1998
On August 18, 1998, LTC transferred six properties operated by Karrington to the Company. Rental income from August 18, 1998 to December 31, 1998 on the Karrington properties was $1,317,000. On September 30, 1998, LTC transferred the remaining seven real estate properties contributed to the Company in connection with the Distribution. Rental income on these seven properties was $855,000 for the period from October 1, 1998 to December 31, 1998. Interest income on the Company's investment in Regent Assisted Living, Inc. and Assisted Living Concepts, Inc. convertible subordinated debentures was $475,000. Interest and other income consisted of $133,000 in dividends on LTC common stock and a gain on the sale of Regent common stock of $86,000.
Mortgage interest expense includes $467,000 on a 7.27% mortgage loan of $17,400,000 obtained by the Company in August 1998 and interest of $666,000 on mortgage debt with a weighted average rate of 9.1% assumed in connection with the Distribution. Interest expense of $711,000 on the unsecured line of credit from LTC represents interest at 10% on the average borrowings under the unsecured credit line provided by LTC.
Depreciation expense of $586,000 consists of depreciation from August 18, 1998 to December 31, 1998 on the Karrington properties of $359,000 and depreciation of $227,000 from October 1, 1998 to December 31, 1998 on the remaining seven properties transferred to the Company in the Distribution.
General and administrative expenses were $467,000, the majority of which relates to a fee of $350,000 for services provided by LTC under the administrative services agreement.
No benefit for income taxes was recorded since the Company believes that it is more likely than not that future taxable income will not be sufficient to realize tax benefits associated with net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
In connection with the formation and capitalization of the Company, LTC provided the Company with a $20.0 million unsecured line of credit. Borrowings outstanding under the unsecured line of credit bear interest at 10% and mature in 2008. (See "Item 8. Financial Statements -Note. 3 Distribution of LTC's Investment in the Company for a more complete discussion of the formation and capitalization of the Company".) As of December 31, 1998, the Company had borrowings outstanding under the unsecured line of credit of $16,528,000. In addition to amounts available under the unsecured line of credit, as of December 31, 1998, the Company owns unencumbered assets consisting of approximately $16,050,000 in real estate, $10,886,000 in convertible subordinated debentures and $3,632,000 in marketable equity securities.
During 1998, the Company utilized working capital and borrowings under the line of credit to:
- - repurchase 138,600 shares of its common stock for an aggregate purchase price of $384,000;
- - purchase $8,500,000 principal amount of Regent Assisted Living, Inc. 7.5% convertible subordinated debentures due 2008 (fair value approximates face value);
- - purchase $3,000,000 principal amount of Assisted Living Concepts, Inc. 5.625% convertible subordinated debentures due 2003 for approximately $2,160,000 (fair value of $2,386,000; amortized cost $2,191,000);
- - purchase 194,100 shares of LTC common stock for an aggregate purchase price of $3,308,000 (fair value of $3,227,000).
In August 1998, the Company obtained mortgage financing of $17,400,000 from a third-party lender on four of the unencumbered properties transferred from LTC in the Distribution. The mortgage loan bears interest at 7.27% and matures in August 2008. Proceeds were used to repay borrowings under the line of credit.
Subsequent to December 31, 1998, the Company utilized borrowings under the line of credit to purchase an additional 40,058 shares of LTC common stock for approximately $585,000 and an additional 453,400 shares of its own common stock for approximately $1,240,000.
The Company anticipates that cash flow from operations will be adequate to meet its short-term liquidity requirements. The Company expects to meet its long term liquidity requirements such as property acquisitions and development, the granting of high yield loans, the purchase of equity investments and mortgage debt maturities through the most advantageous sources of capital available to the Company at that time. This may include, but not be limited to, the sale of common stock, preferred stock or debt securities through public offerings or private placements, the incurrence of indebtedness through secured or unsecured borrowings and the reinvestment of proceeds from the disposition of assets. Currently the Company has no external source of financing and the Company has not received any commitment with respect to any funds needed in the future. The Company expects to be able to access capital markets or to seek other financing, but there can be no assurance that it will be able to do so at all or in amounts or on terms acceptable to the Company.
As of December 31, 1998, the Company had no commitments to purchase any additional assets. The Company intends to operate its business as described herein, and may purchase additional assets from time to time in the future. The purchase of additional assets will be contingent upon securing adequate funding on terms acceptable to the Company. The Company is not aware of any material unfavorable trends in either capital resources or the outlook for long-term cash generation; nor, does it expect any material changes in the availability and relative cost of such capital resources.
YEAR 2000
Currently many computer programs assume the first two digits of a year are "19" and simply identify a year by the last two digits. It is widely anticipated that, beginning in the year 2000 when the first two digits of a year are "20" rather than "19", these computer programs will incorrectly identify the year (i.e. the year 2000 will be incorrectly identified as 1900). Such miscalculations could result in the disruption of operations that are reliant on these computer programs. Computer programs that identify a year by four digits are deemed to be year 2000 compliant. The statements in this section include year 2000 readiness disclosure within the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998.
STATUS OF THE COMPANY'S INFORMATION TECHNOLOGY SYSTEMS AND NON-INFORMATION TECHNOLOGY SYSTEMS. The Company's primary use of information technology systems is its internal accounting and information management software (collectively the "Systems"). The Company has evaluated the Systems to assess whether they will function properly with respect to dates in the year 2000 and beyond. Systems that were determined to be non-compliant with the year 2000 and beyond will be upgraded or replaced.
Implementation of year 2000 compliant Systems and upgrades to existing Systems are expected to be completed by mid-1999. The total cost associated with modifications required to become year 2000 compliant will not be material to the Company's financial position, results of operations or liquidity. Due to the Company's limited reliance on complex Systems, the Company believes the year 2000 issue, as it relates to its internal Systems, will not have a material adverse effect upon the Company's financial position, results of operations or liquidity.
The Company will also have year 2000 exposure in non-information technology areas as it relates to owned properties and its leased corporate offices. There is a risk that embedded chips in elevators, security systems, electrical systems and similar technology-driven devices may stop functioning on January 1, 2000. All of the Company's owned properties are leased under triple-net leases and as such, the cost to repair any of these items will be paid by the lessee. While any disruption in services at our corporate offices due to failure of non-information technology systems may be inconvenient and disruptive to day-to-day activities, it is not expected to have a material adverse effect on our financial position, results of operations or liquidity.
EXPOSURE TO THIRD PARTY YEAR 2000 ISSUES. The Company depends upon the following third parties:
- - its tenants and other third parties in which it has made investments in their debt and equity securities for rents and cash flows;
- - its financial institutions for availability of working capital; and
- - its transfer agent to maintain and track investor information.
If our primary tenants or other third parties in which we have made investments are not year 2000 compliant, or if they face disruptions in their cash flows due to year 2000 issues, we could face significant temporary disruptions in our cash flows after that date. These disruptions could be compounded if the commercial banks that process our cash receipts and disbursements are not year 2000 compliant.
Neither we nor our lessees can be assured that the federal and state governments, upon which our lessees rely for Medicare and Medicaid revenue, will be in compliance in a timely manner. The General Accounting Office has reported that the Health Care Financing Administration, which runs Medicare, is behind schedule in taking steps to deal with the year 2000 issue and that it is highly unlikely that all of the Medicare systems will be compliant in time to ensure the delivery of uninterrupted benefits and services into the year 2000. The General Accounting Office has also reported that, based upon its survey of the states, the District of Columbia and three territories, less than 16% of the automated systems used by state and local government to administer Medicaid are reported to be year 2000 compliant. Due to the general uncertainty surrounding the readiness of third-party tenants and other third-parties, including the federal and state governments, with which the Company and its lessees does business, the Company is unable at this time to determine whether non-compliance with the year 2000 issue by third-parties will have a material impact on the Company's financial position, results of operations or liquidity.
CONTINGENCY PLAN. In the event we experience a significant disruption in cash receipts due to the a delay in Medicare or Medicaid receipts by our tenants or due to other year 2000 non-compliance issues, we would seek additional liquidity from our lenders and slow our investment activity.
Readers are cautioned that forward-looking statements contained in the above discussion regarding year 2000 compliance should be read in conjunction with the disclosure under the heading -Statement Regarding Forward Looking Disclosure.
STATEMENT REGARDING FORWARD LOOKING DISCLOSURE
Certain information contained in this report includes forward looking statements, which can be identified by the use of forward looking terminology such as "may", "will", "expect", "should" or comparable terms or negatives thereof. These statements involve risks and uncertainties that could cause actual results to differ materially from those described in the statements. These risks and uncertainties include (without limitation) the following: the effect of economic and market conditions and changes in interest rates, government policy relating to the health care industry including changes in reimbursement levels under the Medicare and Medicaid programs, changes in reimbursement by other third party payors, the financial strength of the operators of the Company's facilities as it affects the continuing ability of such operators to meet their obligations to the Company under the terms of the Company's agreements with its borrowers and operators, the amount and the timing of additional investments, access to capital markets and changes in tax laws and regulations.
ITEM 7a.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Readers are cautioned that statements contained in this section are "Quantitative and Qualitative Disclosures About Market Risk" are forward looking and should be read in conjunction with the disclosure under the heading "-Statement Regarding Forward Looking Disclosure" set forth above.
The Company is exposed to market risks associated with fluctuations in interest rates on its debt and investments in debt securities and fluctuations in equity prices on its investment in equity and convertible debt securities. These market risks are sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. The Company does not use interest rate contracts or other types of derivative financial instruments.
All of the Company's investments in debt securities and secured mortgage loans payable at December 31, 1998 have fixed interest rates. Changes in interest rates generally impact the fair value, but not future earnings or cash flows of investments in debt and equity securities and fixed rate debt. At December 31, 1998, based on prevailing interest rates for comparable loans and estimates made by management, the fair value of our mortgage loans payable was approximately $39,285,000. The carrying value and weighted average interest rate for mortgage loans payable was $46,527,000 and 8.4%, respectively at December 31, 1998. At December 31, 1998, based on quoted market values, interest rates for comparable securities and estimates made by management, the fair value of the Company's investment in debt and equity securities was $14,518,000. The Company does not believe that the future market rate risks associated with its investments in debt and equity securities and debt will have a material impact on the Company or its future operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders LTC Healthcare, Inc.
We have audited the accompanying consolidated balance sheet of LTC Healthcare, Inc. as of December 31, 1998 and the related consolidated statement of income, stockholders' equity, and cash flows for the period from inception (March 25, 1998) to December 31, 1998. Our audit also included the financial statement schedule listed at Item 14(d). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LTC Healthcare, Inc. at December 31, 1998, and the consolidated results of its operations and its cash flows for the period from inception (March 25, 1998) to 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, present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Los Angeles, California January 19, 1999, except Note 13, as to which the date is March 19, 1999
LTC HEALTHCARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
See accompanying notes
LTC HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
See accompanying notes
LTC HEALTHCARE, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
See accompanying notes
LTC HEALTHCARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
LTC Healthcare, Inc. (the "Company"), a Nevada corporation, was incorporated on March 20, 1998 and began operations on March 25, 1998 to engage in the following activities: (i) ownership of leveraged properties leased to third parties; (ii) ownership of secured high yield mortgage loans; (iii) operation of long-term care facilities; (iv) development of long-term care properties, and (v) ownership of equity investments in long-term care companies.
The Company was originally a preferred stock subsidiary of LTC Properties, Inc. ("LTC"), a Maryland corporation and real estate investment trust. On September 30, 1998, concurrently with the conversion of all shares of Company non-voting common stock held by LTC into voting common stock of the Company, LTC completed the spin-off of Company common stock through a taxable dividend to holders of LTC common stock, convertible subordinated debentures and Series C Preferred Stock (the "Distribution"). Upon completion of the Distribution, the Company began operating as a separate public company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and controlled partnerships. All intercompany accounts and transactions have been eliminated in consolidation.
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 amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
CASH EQUIVALENTS. Cash equivalents consist of highly liquid investments with a maturity of three months or less and are stated at cost which approximates market.
REAL ESTATE. Real estate assets transferred to the Company from LTC are recorded at LTC's historical cost. See Note 3. -Distribution of LTC's Investment in the Company. Land and buildings and improvements acquired by the Company are recorded at the Company's cost. Impairment losses are recorded when events or changes in circumstances indicate the asset is impaired and the undiscounted cash flows estimated to be generated by the asset are less than the carrying amount. Impairment losses are measured as the amount by which the carrying amount of the real estate exceeds the fair value. Management assesses the recoverability of the carrying value of its assets on a property by property basis. Depreciation is provided on a straight-line basis over the estimated useful lives of 7 years for equipment and 35 years for buildings.
INVESTMENTS IN DEBT AND EQUITY SECURITIES. Investments in debt and equity securities are accounted for at fair value as available-for-sale securities. Unrealized holding gains and losses resulting from changes in the fair value are reported as a separate component of stockholders' equity and comprehensive income.
REVENUE RECOGNITION. Base rental revenue is recognized using the straight-line method by averaging annual minimum rents over the terms of the leases. Contingent rental income, which is generated by a
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
percentage of increased revenue over a specified base period revenue of the long-term care facilities, is recognized as earned.
GENERAL AND ADMINISTRATIVE EXPENSES. The Company has entered into an agreement with LTC whereby LTC will provide space and management and administrative services to the Company, including the ability to use the services of LTC's employees in connection with the Company's business (the "Administrative Services Agreement"). In exchange for these services, the Company will pay a monthly fee equal to 25% of the aggregate amount of all wages, salaries and bonuses paid to LTC employees and the aggregate amount of rent paid by LTC for rental of its principal corporate offices. See Note 3. - -Distribution of LTC's Investment in the Company.
INCOME TAXES. Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases and book bases of assets and liabilities at each year end based on enacted laws and statutory tax rates applicable to the years in which the differences are expected to effect taxable income.
STOCK-BASED COMPENSATION. The Company has adopted the disclosure requirements of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED COMPENSATION" but accounts for stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25.
INDUSTRY SEGMENTS. Management allocates resources and assesses performance on an individual property or investment basis. The Company has aggregated its investments into a single operating segment since they consist primarily of long-term care real estate properties and long-term care debt and equity securities.
CONCENTRATION OF CREDIT RISKS. As of December 31, 1998, Integrated Health Services, Inc. ("IHS"), Sun Healthcare Group, Inc., through a wholly-owned subsidiary, ("Sun") and Karrington Health, Inc., ("Karrington") were the Company's largest operators leasing approximately 11%, 25% and 60% of the Company's gross real estate investments, respectively. In addition, as of December 31, 1998, the Company's investment of $8,500,000 in Regent Assisted Living, Inc. ("Regent") convertible subordinated debentures represented 11% of the Company's total assets. See Note 5. - Convertible Subordinated Debentures. The Company's financial position, results of operations and liquidity could be adversely affected by financial difficulties experienced by IHS, Sun, Karrington or Regent, including bankruptcy, insolvency or general downturn in business, or in the event IHS, Sun, or Karrington does not renew and/or extend its leases with the Company as they expire. IHS, Sun, Karrington and Regent are publicly traded companies, and as such are subject to the filing requirements of the Securities and Exchange Commission
On October 18, 1998, Sunrise Assisted Living, Inc. ("Sunrise") and Karrington announced a definitive agreement of merger whereby Sunrise would acquire Karrington. The acquisition is expected to close during the second quarter of 1999.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table, which is not covered by the Report of Independent Auditors on page 19, contains summary information (in thousands) for IHS, Sun, Karrington and Regent that was extracted from public reports on file with the Securities and Exchange Commission.
3. DISTRIBUTION OF LTC'S INVESTMENT IN THE COMPANY
During the period from inception (March 25, 1998) to September 30, 1998, LTC acquired 4,002 shares of the Company's non-voting common stock for $2,001,000 and contributed equity investments with a book value of $788,000, 13 real estate properties with a gross book value of $65,182,000 (net book value of $61,462,000) that were encumbered by $29,263,000 of mortgage debt on seven of the properties and a minority interest liability of $3,461,000, and other related assets and liabilities with a book value of $93,000 to the Company in exchange for an additional 36,000 shares of Company non-voting common stock and borrowings by the Company under the unsecured line of credit provided by LTC of $21,396,000. During 1998, the Company borrowed an additional $12,800,000 under the unsecured line of credit. Subsequent to the contribution of the above assets and liabilities by LTC to the Company, the Company obtained mortgage financing of $17,400,000 from a third-party lender on four of the unencumbered properties. The Company
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
utilized proceeds from the mortgage debt and cash on hand to repay borrowings of $17,668,000 under the unsecured line of credit provided by LTC.
On September 30, 1998, the 40,002 shares of Company non-voting common stock held by LTC were converted into 3,335,882 shares of Company voting common stock. Concurrently, LTC completed the spin-off of all Company voting common stock through a taxable dividend distribution to the holders of LTC common stock, Cumulative Convertible Series C Preferred Stock ("Series C Preferred Stock") and Convertible Subordinated Debentures (the "Debentures"). One share of Company common stock was distributed to each holder of LTC common stock, Series C Preferred Stock and Debentures for each ten shares of LTC common stock owned and for each ten shares of LTC common stock that would have been issued upon conversion of the Debentures and Series C Preferred Stock. Upon completion of the Distribution, the Company began operating as a separate public company.
For book purposes, the net assets and liabilities transferred to the Company by LTC were transferred at LTC's book value of approximately $10,224,000. The Distribution was a taxable dividend distribution by LTC and accordingly, for tax purposes, the net assets and liabilities were transferred at their net fair market value of approximately $15,650,000 ($4.69 per share of Company common stock)(unauditied).
The Company and LTC have entered into various agreements which, among other things, provide for a sharing of corporate overhead under an administrative services agreement. During the period ended December 31, 1998, LTC charged the Company an administrative services fee of approximately $350,000.
4. REAL ESTATE INVESTMENTS
As of December 31, 1998, the Company had investments in 13 properties located in five states. The properties include seven skilled nursing facilities with a total of 914 beds, five assisted living residences with a total of 293 units and one Alzheimer facility with 26 units all of which were contributed to the Company by LTC in connection with the Distribution.
Owned long-term facilities are leased under operating leases generally with an initial term of ten to twelve years. Many of the leases contain renewal options and some contain options that permit the operators to purchase the facilities. The leases provide for a fixed minimum base rent during the initial and renewal periods. Most of the leases provide for annual fixed rent increases or increases based on increases in consumer price indices over the term of the lease. In addition, certain of the Company's leases provide for additional rent through revenue participation (as defined on the lease agreement) in incremental revenues generated by the facilities, over a defined base period, effective at various times during the term of the lease. Each lease is a triple net lease that requires the lessee to provide for the payment of all taxes, insurance, maintenance and repair (capital and non-capital expenditures),and other costs necessary in the operation of the facility.
Depreciation expense on buildings and improvements was $586,000 for the year ended December 31, 1998.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum base rents receivable under the remaining non-cancelable terms of operating leases are: $6,906,000, $6,957,000, $6,758,000, $6,401,000, $4,191,000 and $51,272,000 for the years ending December 31, 1999, 2000, 2001, 2002 and 2003 and thereafter.
5. CONVERTIBLE SUBORDINATED DEBENTURES
During 1998, the Company purchased $8,500,000 principal amount of convertible subordinated debentures from Regent (the "Regent Debentures"). The Regent Debentures mature on March 31, 2008, bear interest at 7.5% and are convertible into Regent common stock at $7.50 per share. Regent can require conversion of the Regent Debentures at such time as the Regent common stock trades at $12.00 per share or more for 30 consecutive days. As of December 31, 1998, the purchase price approximated the fair value of the Regent Debentures.
During October 1998, the Company purchased $3,000,000 principal amount of Assisted Living Concepts, Inc. ("ALC") 5.625% convertible subordinated debentures due 2003 for approximately $2,160,000. As of December 31, 1998, the fair value of the ALC convertible debentures, based on quoted market prices, was approximately $2,386,000.
6. EQUITY INVESTMENTS
During 1998, the Company purchased for investment purposes, 194,100 shares of LTC common stock for an aggregate cost of approximately $3,308,000. As of December 31, 1998, the fair value of the Company's investment in LTC stock, based on quoted market prices, was $3,227,000.
LTC transferred equity investments consisting of 69,000 shares of Regent common stock and 30,847 shares of ALC common stock to the Company. Subsequent to the transfer by LTC, the Company sold its investment in Regent common stock for total proceeds of approximately $388,000 and recognized a gain of approximately $86,000. As of December 31, 1998 the ALC common stock was recorded at its fair value of $405,000 (net of an $81,000 unrealized loss).
7. LINE OF CREDIT FROM LTC
On March 30, 1998, the Company obtained an $8,000,000 unsecured line of credit from LTC. On May 19, 1998, the amount available under the unsecured line of credit was increased to $20,000,000. The line of credit bears interest at 10% and matures in March 2008. As of December 31, 1998, borrowings of $16,528,000 were outstanding under the line of credit. During 1998, the Company recorded interest expense under the unsecured line of credit of $711,000.
8. MORTGAGES PAYABLE
In connection with the transfer of seven real estate properties from LTC to the Company, the Company assumed non-recourse mortgage loans totaling $29,263,000 that bear interest at a weighted average rate of 9.1%. See Note 3.-Distribution of LTC's Investment in the Company.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In August 1998, the Company obtained mortgage financing of $17,400,000 from a third-party lender on four of the unencumbered properties transferred from LTC. The mortgage loan bears interest at 7.27% and matures in August 2008.
At December 31, 1998, based on prevailing interest rates for comparable loans and estimates made by management, the fair value of our mortgage loans payable was approximately $39,285,000. Aggregate scheduled principal payments for the mortgage loans payable as of December 31, 1998 were $571,000, $617,000, $674,000, $3,988,000, $754,000, and $39,923,000 in 1999, 2000, 2001, 2002, 2003 and thereafter.
9. STOCKHOLDERS' EQUITY
INITIAL CAPITALIZATION. On March 25, 1998, LTC acquired 2 shares of non-voting common stock for $1,000 and Christopher T. Ishikawa, Senior Vice President and Chief Investment Officer of LTC, acquired 2 shares of voting common stock in exchange for a $1,000 promissory note. LTC acquired an additional 4,000 shares of non-voting common stock for $2,000,000 and 36,000 shares of non-voting common stock in exchange for the contribution of certain assets and liabilities. On September 30, 1998, the 2 shares of voting common stock acquired by Mr. Ishikawa were retired in return for the cancellation of the $1,000 promissory note.
On September 30, 1998, the 40,002 shares of Company non-voting common stock held by the LTC were converted into 3,335,882 shares of Company voting common stock. On September 30, 1998, the date of the Distribution, the Company owned 124,500 shares of LTC common stock and as a result of the Distribution, received 12,450 shares of treasury stock. See Note 3.-Distribution of LTC's Investment in the Company.
REPURCHASE OF COMMON STOCK. During 1998, the Company's Board of Directors approved the repurchase of up to 300,000 shares of its common stock with such purchases to be made in the open market, or in negotiated transactions, at such times and at such prices as management may decide. As of December 31, 1998, the Company repurchased a total of 138,600 shares of its common stock in the open market at an aggregate cost of $384,000.
STOCK BASED COMPENSATION PLAN. During 1998, the Company adopted the 1998 Equity Participation Plan (the "1998 Plan") under which 500,000 shares of common stock have been reserved for stock based compensation awards. The 1998 Plan provides for the issuance of incentive and nonqualified stock options, restricted stock and other stock based awards to officers, employees, non-employee directors and consultants. The terms of awards granted under the 1998 Plan are set by the Company's compensation committee at its discretion, however, in the case of incentive stock options, the term may not exceed ten years from the date of grant.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarized nonqualified stock option activity for the period from inception (March 25, 1998) to December 31, 1998:
All options outstanding as of December 31, 1998 have a ten year life and vest equally over three years from the original date of grant based on continued employment as of each respective vesting date. Unexercised options expire seven years after the date of vesting.
The fair value of options granted during 1998 was estimated using the Black-Scholes valuation model and assumptions as of the grant date. In determining the estimated fair value of options granted, the Company assumed a life expectancy of five years from the options grant date, volatility factor of the expected market price of the Company's common stock of 1.559, and a risk free interest rate of 4.70%. Based on the above assumptions, the estimated fair value of options granted was $2.32 per share. As of December 31, 1998 the average remaining contractual life of the outstanding options was 9.8 years. Had compensation cost been recorded under the provisions of SFAS No. 123, pro forma net loss would have been $157,000 and pro forma basic and diluted loss per share would have been $0.05 per share.
10. INCOME TAXES
For federal and state income tax purposes, the Company recorded the assets and liabilities transferred from LTC at the net fair market value which was approximately $5,426,000 higher than their net book value at the date of transfer (unaudited). The excess of fair market value over book value was recorded as a deferred tax asset. Sufficient taxable income must be generated in future years to realize the tax benefit associated with the net deferred tax asset. The Company believes that sufficient doubt exists as to whether it is more likely than not that future taxable income will be sufficient to realize such tax benefits and, accordingly, a valuation allowance was established against the deferred tax asset resulting from the transfer of assets and liabilities from LTC and net operating loss carryforwards. See Note 3.-Distribution of LTC's Investment in the Company.
At December 31, 1998, the Company had, for federal and California tax purposes, net operating loss carryforwards totaling $379,000 and $49,000 respectively (expiring in 2018 for federal and 2003 for California).
SFAS No. 109 requires the reduction of the deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that a portion or all of the deferred tax asset will not be realized. For the year ended December 31, 1998, the Company has established a $41,000 valuation allowance for net operating loss carryforward which currently is not expected to be utilized.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The reconciliation between the statutory provision for income taxes and the actual provision for income taxes is shown as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
The components of the Company's deferred tax assets and liabilities are as follows:
11. NET LOSS PER SHARE
The Company had no dilutive securities for the period ended December 31, 1998. Weighted average shares outstanding for the period ended December 31, 1998 were calculated assuming the conversion of 40,002 shares of non-voting common stock held by LTC into 3,335,882 shares of voting common stock and the 151,050 shares of treasury stock obtained by the Company occurred at the beginning of the period. See Note 9.--Stockholders' Equity.
LTC HEALTHCARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
13. SUBSEQUENT EVENTS
During 1998, the Company's board of directors authorized the repurchase of 300,000 shares of the Company's common stock. As of December 31, 1998 the Company had repurchased 138,600 shares of its' common stock for approximately $384,000. As of January 13, 1999, the Company had repurchased an additional 161,400 shares for approximately $444,000 and had repurchased all the shares authorized under the 1998 stock repurchase plan. On January 14, 1999 the Company's board of directors authorized the repurchase of 300,000 additional shares of the Company's common stock. As of March 19, 1999, the Company had repurchased 292,000 shares of its common stock under the 1999 stock repurchase plan, for approximately $796,000. In addition, the Company purchased 40,058 shares of LTC common stock for approximately $585,000.
During 1999, the Company entered into a transaction with National Healthcare Investors, Inc. ("NHI"), whereby LTC purchased a note receivable of $13,691,000 from an NHI subsidiary (the "NHI Note"). The NHI Note is a non-recourse note secured by four skilled nursing facilities that bears interest at an annual rate of 11% (calculated using the 365/360 day methodology resulting in an effective interest rate of approximately 11.2%), and is fully amortizing with a final maturity of January 1, 2009. The Company financed the acquisition of the NHI Note with a non-recourse note payable to NHI for $13,691,000 that bears interest at 10.75% (effective rate of 10.9%) and matures on January 1, 2009 concurrently with the NHI Note.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Incorporated herein by reference from the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held May 25, 1999, to be filed pursuant to Regulation 14A.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference from the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held May 25, 1999, to be filed pursuant to Regulation 14A.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference from the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held May 25, 1999, to be filed pursuant to Regulation 14A.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from the Company's definitive proxy statement for the Annual Meeting of Stockholders to be held May 25, 1999, to be filed pursuant to Regulation 14A.
ITEM 14.
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K.
(a) Financial Statements
The financial statements are filed as Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
None.
(c) Exhibits
The exhibits in the accompanying index to exhibits are filed as part of this Annual Report on Form 10-K.
(d) Financial Statement Schedules
Schedule XI. Real Estate and Accumulated Depreciation is filed as part of this Annual Report on Form 10-K. All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedules.
ITEM 14 (c). INDEX TO EXHIBITS
In accordance with Item 601(b)(4)(iii) of Regulation S-K, certain instruments pertaining to Registrant's long-term debt have not been filed; copies thereof will be furnished to the Securities and Exchange Commission upon request.
LTC HEALTHCARE, INC. SCHEDULE XI REAL ESTATE AND ACCUMULATED DEPRECIATION (in thousands)
(1) The aggregate cost for federal income tax purposes is approximately $67,000,000. (2) Depreciation for building is calculated rising a 35 year life for skilled nursing facilities and a 40 year life for assisted living residences and additions to facilities. Depreciation for furniture and fixtures is calculated based on a 7 year life for all facilities. (3) Single note backed by four facilities in Ohio.
Activity for the year ended December 31, 1998 is as follows:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LTC Healthcare, Inc. Registrant
Dated: March 31, 1999 By: /s/ JAMES J. PIECZYNSKI ----------------------- JAMES J. PIECZYNSKI President, Chief Financial Officer and Director
/s/ ANDRE C. DIMITRIADIS - ------------------------------ ANDRE C. DIMITRIADIS Chairman of the Board, Chief March 31, 1999 Executive Officer and Director
/s/ JAMES J. PIECZYNSKI - ------------------------------ JAMES J. PIECZYNSKI President, Chief Financial March 31, 1999 Officer and Director
/s/ STEVEN STUART - ------------------------------ STEVEN STUART Director March 31, 1999
/s/ BARY G. BAILEY - ------------------------------ BARY G. BAILEY Director March 31, 1999