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ALC > SEC Filings for ALC > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Form 10-K for ASSISTED LIVING CONCEPTS INC


14-Mar-2013

Annual Report


ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. Forward-looking statements are subject to risks, uncertainties and assumptions which could cause actual results to differ materially from those projected, including those described in Item 1A, "Risk Factors," in Part I of this report and in "Forward-Looking Statements and Cautionary Factors" in Item 9B, "Other Information," in Part II of this report.

The following discussion should be read in conjunction with our consolidated financial statements and the related notes to the consolidated financial statements in Item 8, "Financial Statements and Supplementary Data," in Part II of this report.

Executive Overview

In the second quarter of 2012, we began a review of our operations which included identifying and evaluating operational issues affecting the delivery of care and services to our residents. Based upon our review, we believe that certain failures to meet ALC's established performance standards have damaged ALC's reputation in the marketplace and contributed to ALC's inability to increase private pay occupancy as rapidly as desired. We initiated a number of measures to enhance the performance of our resident services to restore in all affected facilities the level of quality care and service expected by our residents, their families, the regulators, the Board of Directors and the stakeholders of the Company and to re-establish our reputation with regulators, our stakeholders and the communities in which our facilities are located. In addition to naming Dr. Charles H. Roadman II, M.D. as Interim President and Chief Executive Officer, we also:

Formed a Quality Review Committee of the Board of Directors

o Engaged an independent consultant to review the quality of our resident services performance

o Expect to perform on-going independent quality reviews of residences

Enhanced clinical procedures and quality performance standards

o Hired a senior vice president of quality services and risk management

o Added approximately 800 employees to enhance quality and clinical procedures

o Implemented a satisfaction survey process to monitor progress

Revised staffing patterns to enhance the residents' experience and provide quality outcomes

Met with state regulators to resolve licensing issues in high priority states

As compared to first two quarters of 2012, these measures resulted in approximately $9.9 million of additional salaries, wages and benefits, $0.8 million in additional food and kitchen related expenses and $0.2 million of consulting expenses during the last two quarters of 2012. We believe they are necessary to accomplish our longer term goals of improving occupancy and profitability. In the fourth quarter of 2012, we believe those quality improvement measures significantly contributed to an increase in average occupancy of 131 units as compared to the third quarter of 2012.

Average private pay occupancy in the year ended December 31, 2012 decreased by 178 units as compared to the year ended December 31, 2011. Average private pay occupied units in all residences in 2012 were 5,482; 5,365; 5,251 and 5,382 for the first, second, third and fourth quarters, respectively. Beginning in the third quarter of 2012, we began more aggressive room and board promotional discounts resulting in lower average private pay rate per unit growth than prior years. Private pay rate growth per unit was 1.1%, 0.5% and 3.4% for the years ended December 31, 2012, 2011 and 2010, respectively. We believe our success in attracting and maintaining private pay residents in 2012 was, and may continue to be, affected by the current poor general economic conditions. Continuing poor general economic conditions, especially those related to high unemployment levels and poor housing markets, affect private pay occupancy and rate because:

family members are more willing and able to provide care at home;

residents have insufficient investment income or are unable to obtain necessary funds from the sale of their homes or other investments; and

independent living facilities are accepting traditional assisted living residents with home care services.

The impact of these factors is referred to in this report as the "Economic Impact" In the event general economic conditions fail to improve or get worse, we believe there can be negative pressure on our private pay occupancy and rates.


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Historically, a relatively large proportion of our residents paid for assisted living services through Medicaid programs. Since December 31, 2005, we have reduced the proportion of our residents who pay through Medicaid programs from 30% to less than 1% at December 31, 2012. We believe the planned reduction in Medicaid occupancy is a necessary part of our long-term operating strategy to improve our overall revenue base because:

our private pay rates generally exceed those paid through Medicaid reimbursement programs by 50% to 70%;

we reduce our exposure to reductions in reimbursement rates provided by government programs; and

our private pay residents typically have less severe health needs and require fewer services than residents funded by Medicaid programs, resulting in:

o a better fit for our social and wellness model; and

o a safer environment for employees and the other residents in our communities.

We review our rates on an annual basis or as market conditions dictate. As in past years, we implemented rate increases as of the first of January. We expect overall private pay rate increases in 2013 to be less than 1%.

Average occupancy as a percentage of total available units for all residences in the years ended December 31, 2012, 2011 and 2010 was 60.5%, 62.4%, and 62.5%, respectively. Average private pay occupancy as a percentage of total available units for all residences in the years ended December 31, 2012, 2011 and 2010 was 60.5%, 61.6%, and 60.9%, respectively. Average private pay occupancy as a percentage of total occupied units in the years ended December 31, 2012, 2011 and 2010 for all residences was 99.9%, 98.8%, and 97.3%, respectively. Private pay revenue as a percentage of total revenues for all residences in the years ended December 31, 2012, 2011 and 2010 was 99.9%, 99.3% and 98.3%, respectively.

From time to time, we may increase or reduce the number of units we actively operate, which may affect reported occupancy and occupancy percentages.

In the third quarter of 2012, we agreed to a resolution with the State of Alabama in which we voluntarily surrendered the assisted living license for 50 units which are part of a campus consisting of 164 independent living and assisted living units in Alabama, and the State of Alabama withdrew its notice of revocation asserting past regulatory noncompliance. The apartments have reopened as independent living units. We have several other residences with various degrees of regulatory issues. The outcomes of these issues cannot be determined at this time.

Credit Agreement Amendment

On December 31, 2012, ALC entered into the Third Amendment with the lenders currently party to the U.S. Bank Credit Facility and U.S. Bank.

Pursuant to the Third Amendment, the lenders waived "Existing Alleged Defaults" under the U.S. Bank Credit Facility potentially arising from certain events and matters, and specifically waived any noncompliance with the maximum consolidated leverage ratio, which occurs (i) on or before December 31, 2012, (ii) from the date of the Third Amendment through March 31, 2013, and (iii) from and after the date ALC provides the lenders with a fully-executed agreement which provides for the repayment of all of the obligations under the U.S. Bank Credit Facility within a reasonable period of time through August 15, 2013, subject to extension to September 30, 2013 (for so long as such contemplated agreement is in full force and effect). The Merger Agreement was delivered to U.S. Bank on February 27, 2013 in satisfaction of the March 31, 2013 requirement described above. As a result, pursuant to the Third Amendment, compliance with the maximum consolidated leverage ratio was waived through August 15, 2013, subject to extension to September 30, 2013, for so long as the Merger Agreement remains in full force and effect.

Pursuant to the Third Amendment, the listing of an event or matter as an "Existing Alleged Default" is not, nor should it be deemed to be, an admission or agreement by ALC that any of the following singly or collectively, are a default or an event of default under the U.S. Bank Credit Facility or the documents relating to the U.S. Bank Credit Facility.

One such "Existing Alleged Default" that the lenders waived relates to that certain Amended and Restated Loan Agreement, dated September 30, 2010 (the "TCF Loan"), by and between ALC Three, LLC, as borrower ("TCF Borrower"), ALC, as guarantor, and TCF National Bank ("TCF"). TCF Borrower is a wholly-owned subsidiary of ALC. Due to regulatory issues, ALC or its direct or indirect wholly-owned entities voluntarily surrendered an operating license for a property that is part of the collateral under the TCF Loan, resulting in ALC's anticipated inability to meet the EBITDA covenant under the TCF Loan for such property for the year ending December 31, 2012. Under the terms of the TCF Loan, a breach of the TCF Loan would occur at March 31, 2013 if the EBITDA covenant was not satisfied at December 31, 2012. TCF Borrower, ALC and TCF entered into a First Amendment to Amended and Restated Loan Agreement effective as of December 31, 2012, pursuant to which TCF agreed to release the affected facility from the loan collateral under the TCF Loan and ALC agreed to substitute two facilities into the loan collateral and thereby cure the potential breach of the TCF Loan.


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Other "Existing Alleged Defaults" that the lenders waived include, among other things, the alleged failure to timely disclose to U.S. Bank the receipt of certain correspondence from Red Mortgage Capital, LLC, as servicer ("Red Cap"), the proposed voluntary repayment of approximately $4.1 million to Red Cap, the alleged failure to timely provide to U.S. Bank certain financial reports provided to certain other lenders or servicers, including Red Cap and TCF, the maintenance of a brokerage account that was not subject to a collateral securities agreement for the benefit of the lenders, the receipt and appeal of a notice of revocation of license in connection with a facility, the surrender of the assisted living licenses or "stop placement" notices with respect to certain facilities, the temporary absence of possession of title to eight condominium units in a recently acquired facility and the fact that ALC and its affiliates are parties to certain investigations and lawsuits.

In addition, the Third Amendment includes the following terms, among others:

The interest rate on the loan will be increased by 100 basis points from the base rate plus 2.50% to the base rate plus 3.50% and the unused commitment fee will be 0.625%. Interest and fees will be paid monthly, not quarterly.

ALC will provide to U.S. Bank mortgages on certain properties, which are estimated to represent in the aggregate at least $25 million in fair market value. ALC will also provide the lenders with mortgages or deeds of trust on any properties released by Red Cap as a result of the proposed voluntary repayment of approximately $4.1 million. Such repayment to Red Cap by ALC was required to be made by December 31, 2012; however, on December 20, 2012, ALC and Red Cap entered into an agreement to defer the repayment to January 31, 2013. On January 28, 2013, ALC and Red Cap entered into an agreement to extend the dates by which two of the mortgage loans shall be prepaid to February 28, 2013 and the earlier of the sale of the property or June 30, 2013, respectively. On January 31, 2013 and February 28, 2013, ALC made required repayments to Red Cap.

The lenders will permit ALC to borrow under the revolver and renew letters of credit, absent a default or event of default or other breach of the existing conditions to new borrowings; provided, that ALC will agree to maintain $4 million of unused availability under the revolver, which shall not be subject to the unused commitment fee.

The lenders will not release their mortgages or deeds of trust on the properties otherwise scheduled to be released, which are valued at approximately $17 million.

ALC may not sell any properties mortgaged to the lenders without the consent of the lenders (except for one pre-approved property). Upon any sale of any such mortgaged property (other than the pre-approved property), (i) ALC shall pay the lenders the net proceeds of the sale of such mortgaged property and
(ii) the revolving credit commitment shall be permanently reduced by the amount of such payment.

Except for the voluntary repayment of approximately $4.1 million to Red Cap described above and payments to other secured creditors from the proceeds of the sale of their collateral, if any, ALC will not voluntarily prepay other indebtedness without prepaying the indebtedness owed under the U.S. Bank Credit Facility on a pari passu basis with a corresponding reduction in the commitment.

ALC will provide to the lenders, on or before March 31, 2013, a fully-executed agreement which provides for the repayment of all of the obligations under the U.S. Bank Credit Facility within a reasonable period of time. ALC will close the transaction contemplated by the foregoing agreement by August 15, 2013, subject to extension to September 30, 2013.

ALC will provide the lenders with timely written notice of any defaults or alleged defaults on other indebtedness of $2.5 million or more (instead of $10 million or more).

ALC will provide to U.S. Bank monthly financial statements within 45 days of month-end and weekly 13-week cash flow forecasts.

On or before July 2, 2013, ALC will obtain not less than $15 million from a new credit facility, sale of unencumbered assets, or otherwise.

ALC shall release U.S. Bank, each lender, each letter of credit lender and certain other releases from any and all claims of ALC related to the loan documents arising on or before the date of the Third Amendment.

ALC will no longer have the ability to borrow under any swing loans, as contemplated by the U.S. Bank Credit Facility.

ALC will no longer have the ability to borrow at the eurodollar rate, as contemplated by the U.S. Bank Credit Facility.


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ALC paid, pro rata, a fee of $625,000 to the lenders.

ALC will pay all undisputed, reasonable fees of the lenders in connection with the Third Amendment.

ALC continues to be current with all principal and interest payments due on all its outstanding indebtedness and, although no assurances can be given, management believes that ALC will be able to consummate the transactions contemplated by the Merger Agreement within the timeframe described above as required by the Third Amendment. However, because our borrowings outstanding under the U.S. Bank Credit Facility now expire in the current year pursuant to the Third Amendment, all of our outstanding indebtedness under the U.S. Bank Credit Facility was classified as a current liability in our consolidated financial statements.

If the lenders were to declare a default under the U.S. Bank Credit Facility and ALC's other borrowings subject to cross-default provisions ($23.8 million in total as of December 31, 2012), they could, among other remedies, accelerate the repayment of all existing borrowings, terminate ALC's ability to make new borrowings and foreclose on their liens described above. There is no assurance that ALC would be able to obtain financing to pay amounts owed under such circumstances.

The Merger Agreement

On November 2, 2012, ALC announced that a Special Committee of the Board of Directors would continue its strategic review process to explore corporate alternatives with a view to enhancing shareholder value.

On February 25, 2013, we entered into an Agreement and Plan of Merger with Aid Holdings and Aid Merger Sub, providing for the merger of Aid Merger Sub with and into the Company, with the Company surviving the Merger as a wholly-owned subsidiary of Aid Holdings. Aid Holdings and Aid Merger Sub are affiliates of TPG Capital, L.P. At the effective time of the Merger, each share of Class A Common Stock issued and outstanding immediately prior to the effective time of the Merger (other than shares owned by the Company, Aid Holdings or any direct or indirect subsidiary of either of them) will be converted automatically into the right to receive $12.00 in cash, without interest (the "Class A Per Share Merger Consideration"). Each share of Class B Common Stock issued and outstanding immediately prior to the effective time of the Merger (other than shares owned by the Company, Aid Holdings or any direct or indirect subsidiary of either of them or stockholders who have properly exercised and perfected dissenters' rights under Nevada law) will be converted automatically into the right to receive $12.90 in cash, without interest (as required under the Company's amended and restated articles of incorporation based on the Class A Per Share Merger Consideration).

Consummation of the Merger is subject to various conditions, including, without limitation: (i) the approval by the holders of a majority of the voting power of outstanding shares of Class A Common Stock and Class B Common Stock, voting as a single class (with each share of Class A Common Stock entitled to one vote and each share of Class B Common Stock entitled to ten votes), (ii) the approval by the holders of a majority of the voting power of outstanding shares of Class A Common Stock, excluding shares owned, directly or indirectly, by holders of Class B Common Stock, Aid Holdings, Aid Merger Sub or officers or directors of the Company, or any of their respective affiliates, voting as a single separate class (which condition, pursuant to the terms of the Merger Agreement, may not be waived), (iii) the absence of any law, injunction, judgment or ruling that prohibits, restrains or makes illegal the consummation of the Merger and (iv) the accuracy of the parties' respective representations and warranties and the performance of the parties' respective covenants (in each case, subject to certain materiality thresholds). In addition, the obligation of Aid Holdings and Aid Merger Sub to consummate the Merger is subject to (a) the absence, since the date of the Merger Agreement, of any change, effect, event, development, fact, occurrence or circumstance that, individually or in the aggregate, has had or would reasonably be expected to have a Material Adverse Effect (as defined in the Merger Agreement) and (b) the receipt by Aid Holdings of certain state licenses and permits to operate the Company's facilities. The Merger is expected to close in the summer of 2013, but we cannot be certain when or if the conditions to the closing of the Merger will be satisfied or, to the extent permitted, waived.

Acquisitions

On November 1, 2010, ALC completed the acquisition of nine senior living residences from HCP, Inc. The nine residences were previously leased and operated by ALC under leases expiring between November 2010 and May 2012. The purchase price was $27.5 million in cash plus certain transaction costs. As part of the consideration, ALC reclassified $0.5 million of unamortized leasehold improvements to property and equipment. The nine residences, two of which are located in New Jersey and seven in Texas, contain a total of 365 units.

On June 15, 2012, in connection with litigation filed earlier, we signed and closed on an agreement with Ventas Realty and MLD Delaware Trust ("MLD") to purchase 12 residences consisting of 696 units for a purchase price of $97 million plus $3 million for a litigation settlement fee plus Ventas Realty's expenses in connection with the litigation. The residences, five located in Georgia, four in South Carolina and one in each of Florida, Alabama and Pennsylvania were previously operated by us under a master lease agreements with Ventas Realty and MLD. As part of the purchase agreement, Ventas Realty and MLD have agreed to release all past, present and future claims with respect to the master leases, the residences and the guaranty of lease made by ALC for the benefit of Ventas Realty as well as those set forth in the complaint and amended complaint filed in Ventas Realty, Limited Partnership v. ALC CVMA, LLC, et al., 12-cv-03107, in the United States District Court for the Northern District of Illinois. Additionally, pursuant to the purchase agreement, ALC is obligated to indemnify Ventas against losses from third party claims, arising on or prior to the six-year anniversary of the purchase agreement, relating to the master leases or the residences. The transaction was funded with borrowings available under our U.S. Bank Credit Facility.


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Business Strategies

We plan to grow our revenue and operating income by:

increasing our private pay occupancy;

increasing the attractiveness and operating results of our portfolio by refurbishing and repositioning residences; and

adding or reducing the number of units available in our portfolio by acquiring, expanding upon or divesting assets.

Under the Merger Agreement, the Company has operational and financial restrictions and is obligated to operate its business in the ordinary course. Accordingly, our business strategy is subject to the Merger Agreement.

Increasing our private pay occupancy

We continue to focus on increasing the number of residents in our communities by filling existing vacancies with private pay residents. As discussed above, in the second quarter of 2012 we initiated programs to enhance the performance of our quality standards to improve customer satisfaction and restore our performance to meet quality standards to attract and retain residents. We use a focused sales and marketing effort designed to increase demand for our services among private pay residents and to establish ALC as the provider of choice for residents who value wellness and quality of care. We intend to leverage our fixed cost structure and may provide incentives to attract a larger number of private pay residents.

If general economic conditions fail to improve, our ability to fill vacant units with private pay residents may continue to be limited and the occupancy and revenue challenges may continue.

Increasing the attractiveness and operating results of our portfolio by refurbishing and repositioning residences

We continually evaluate our portfolio to identify opportunities to improve the attractiveness and operating results of our residences. We regularly upgrade and replace items such as flooring, wall coverings, furniture and dishes and flatware at our residences. In addition, from time to time we may temporarily close residences to facilitate refurbishing and repositioning them in the marketplace.

On January 1, 2011 we closed two properties consisting of 39 units in Washington and 35 units in Idaho. In the second quarter of 2011, we closed one property consisting of 23 units in Wisconsin and reopened two properties consisting of 33 units in Oregon and 39 units in Washington. In the fourth quarter of 2011 we closed one property consisting of 60 units in Minnesota. In the first quarter of 2012 we closed one property consisting of 56 units in Washington and in the second quarter of 2012 we closed an additional property consisting of 39 units in Idaho. We also opened an addition of 23 units on a property in Indiana in the fourth quarter of 2012. We believe the temporarily closed residences are located in markets with strong growth potential but require some updating and repositioning in the market. Once underway, refurbishments are expected to take three to nine months to complete. Following refurbishment, we expect these projects will take approximately twelve additional months to stabilize occupancy. We spent approximately $200,000 to $400,000 on each of our reopened refurbishment projects and expect the cost of other refurbishments to be in that range. We own 82% of our residences which provides us with significant flexibility to make such refurbishments.


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Adding to or reducing the number of units available in our portfolio by expanding upon or divesting assets

On June 15, 2012, in connection with the settlement of litigation filed earlier, we signed and closed on an agreement with Ventas Realty and MLD to purchase 12 residences consisting of 696 units for a purchase price of $97 million plus $3 million for a litigation settlement fee plus Ventas Realty's expenses in connection with the litigation. The residences, five located in Georgia, four in South Carolina and one in each of Florida, Alabama and Pennsylvania were previously operated by us under a master lease agreements with Ventas Realty and
MLD. The transaction was funded with borrowings available under our U.S. Bank Credit Facility.

We expect to continue to evaluate our portfolio for assets that may not meet management's long term expectations. Assets that do not meet or are anticipated not to meet our performance expectations criteria may be closed or divested.

The remainder of this Management's Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:

Business Overview: This section provides a general financial description of our business, including the sources and composition of our revenues and operating expenses. In addition, this section outlines the key performance indicators that we use to monitor and manage our business and to anticipate future trends.

Consolidated Results of Operations: This section provides an analysis of our results of operations for the year ended December 31, 2012 compared to the year ended December 31, 2011 and the year ended December 31, 2011 compared to the year ended December 31, 2010.

Liquidity and Capital Resources: This section provides a discussion of our liquidity and capital resources as of December 31, 2012, and our expected future cash needs.

Critical Accounting Policies: This section discusses accounting policies which we consider to be critical to obtain an understanding of our consolidated financial statements because their application on the part of management requires significant judgment and reliance on estimations of matters that are inherently uncertain.

In addition to our core business, ALC holds a share investment in MedX Health Corporation, a Canadian publicly traded corporation and cash or other investments held by Pearson Indemnity Company Ltd. ("Pearson"), our wholly-owned consolidated Bermuda based captive insurance company formed primarily to provide self-insured general and professional liability coverage.

Basis of Presentation of Historical Consolidated Financial Statements

The following is a description of significant events that occurred in our business since January 2010 and how those events affected the basis of presentation of our historical consolidated financial statements:

From December 31, 2007 to December 31, 2012, we constructed and opened 19 new additions consisting of a total of 390 units.

Effective November 1, 2010, we purchased nine residences consisting of 365 units which we had previously leased from HCP, Inc.

Effective June 15, 2012, we purchased 12 residences consisting of 696 units . . .

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