form10k.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
 
(Mark One)
 
 
R
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2012
Or
 
£
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission file number: 001-13498
Assisted Living Concepts, Inc.
(Exact name of registrant as specified in its charter)
Nevada
 
93-1148702
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)

W140 N8981 Lilly Road, Menomonee Falls, Wisconsin 53051
(Address of Principal Executive Offices)
Telephone: (262) 257-8888
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

 
Title of Each Class
 
Name of Each Exchange
On Which Registered
Class A Common Stock, $0.01
 
New York Stock Exchange
par value per share
   

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes £  No R
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes £ No R

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-KR

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check One):
Large accelerated filer £                      Accelerated filer R                         Non-accelerated filer £                    Smaller reporting company £
                                           (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2012 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $129 million.  For purposes of this computation shares of Class B Common Stock were assumed to have the same market value as Class A Common Stock.  Common shares held as of June 30, 2012 by executive officers, directors and holders of more than 5% of the outstanding common shares have been excluded from this computation because such persons or institutions may be deemed to be affiliates.  This determination of affiliate status is not a conclusive determination for any other purpose.

As of March 8, 2013, the registrant had 20,073,025 shares of its Class A Common Stock, $0.01 par value outstanding and 2,897,516 shares of its Class B Common Stock, $0.01 par value outstanding.



 
 

 
 
ASSISTED LIVING CONCEPTS, INC.

FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2012
TABLE OF CONTENTS

 
PAGE
PART I
 
Item 1
3
Item 1A
10
Item 1B
16
Item 2
17
Item 3
17
Item 4
19
 
19
PART II
 
Item 5
21
Item 6
23
Item 7
25
Item 7A
53
Item 8
54
Item 9
54
Item 9A
54
Item 9B
57
PART III
 
Item 10
59
Item 11
61
Item 12
75
Item 13
80
Item 14
81
PART IV
 
Item 15
83
 
F-1
 
S-1
 
EI-1

 
2

 
ASSISTED LIVING CONCEPTS, INC.
PART I

ITEM 1

The Company

As of December 31, 2012, the 211 senior living residences of Assisted Living Concepts, Inc. (“ALC”) and its subsidiaries are located in 20 states in the United States and total 9,348 units.  ALC’s residences typically range from 40 to 60 units and offer residents a supportive, home-like setting and assistance with the activities of daily living.

ALC became an independent, publicly traded company listed on the New York Stock Exchange on November 10, 2006 (the “Separation Date”) when shares of ALC Class A and Class B Common Stock were distributed by Extendicare Inc. (“Extendicare”), to its stockholders (“the Separation”).

References in this report to “Assisted Living Concepts,” “ALC,” “we,” “our,” and “us” refer to Assisted Living Concepts, Inc. and its consolidated subsidiaries, as constituted after the Separation, unless the context otherwise requires.

Effective March 16, 2009, ALC implemented a one-for-five reverse stock split of its Class A and Class B Common Stock and effective  May 20, 2011, ALC implemented a two-for-one stock split of its Class A and Class B Common Stock.  All share amounts, stock prices, and per share data in this report have been adjusted to reflect these stock splits.

History

ALC was formed as a Nevada corporation in 1994.  ALC operated as an independent company until January 31, 2005 when it was acquired by Extendicare Health Services, Inc. (“EHSI”) (the “ALC Purchase”), a wholly-owned subsidiary of Extendicare.  Following the ALC Purchase, Extendicare consolidated its assisted living operations with ALC’s until the Separation.

The following table summarizes the changes in the number of residences and units under operation by ALC since December 31, 2007:

   
Residences
   
Units
 
December 31, 2007
    208       8,535  
Acquisition of eight leased residences
    8       541  
Expansion  of four residences
          78  
December 31, 2008
    216       9,154  
Expansion  of twelve residences
          244  
Combined two residences on one campus
    (1 )      
December 31, 2009
    215       9,398  
Discontinued operations – formerly leased operations
    (4 )     (118 )
Expansion of one residence
          25  
December 31, 2010
    211       9,305  
Expansion of one residence
          20  
December 31, 2011
    211       9,325  
Expansion of one residence
          23  
December 31, 2012
    211       9,348  
 
On June 19, 2006, ALC formed Pearson Insurance Company, LTD (“Pearson”), a wholly-owned, consolidated, Bermuda- based captive insurance company, to self-insure general and professional liability risks.  On July 30, 2009, ALC formed Swan Home Health, LLC (“Swan Home Health”), a wholly-owned consolidated subsidiary, to provide health care services in certain of our residences.  In addition, on October 14, 2010, ALC formed Swan Companion Care, LLC (“Swan Companion Care”), a wholly-owned consolidated subsidiary, to provide health care services in our independent residence located in Alabama.

Financial Presentation

The consolidated financial statements include all senior living residences operated by ALC in the respective periods,  and include Pearson, Swan Home Health and Swan Companion Care since their formation.
 
 
3

 
ALC operates in a single business segment with all revenues generated from those properties located within the United States.

Our Business

We operate senior living residences that provide seniors with a supportive, home-like setting with care and services, including 24-hour assistance with activities of daily living, medication management, life enrichment, health and wellness, and other services either directly from ALC employees or indirectly through wholly-owned health care service subsidiaries. See “Our Services” below.  Our residences are in the middle of a broad spectrum of senior living options that ranges from apartments to skilled nursing facilities.  In general, the type of senior living residence that is appropriate for a senior depends on his or her particular preferences and life circumstances, especially health and physical condition and the corresponding level of care that he or she requires.  Seniors may move into one of our residences by choice or by necessity.  As of December 31, 2012, we have 211 residences containing 9,348 units located in 20 states of which at December 31, 2012, 173 were owned and 38 were leased.

Our residences are purpose-built to meet the special needs of seniors and typically are located in targeted, middle-market suburban bedroom communities that were selected on the basis of a number of factors, including the size of our targeted demographic resident pool in the community.  Our residences include features designed to appeal to seniors and their decision makers.  The majority of our residences are 40 to 60 units, single story, square shaped buildings with an enclosed courtyard, a mix of studio and one-bedroom apartments, and wide hallways to accommodate our residents who use walkers and wheelchairs.  The relatively small number of units in our residences and the design of our buildings enhance our ability to provide effective security and care, while also appealing to seniors who generally prefer easy access to their living quarters, pleasing aesthetics, and simplicity of design. 
 
Our Services

Seniors in our residences are individuals who, for a variety of reasons, elect not to live alone, but do not need the 24-hour medical care provided in skilled nursing facilities.  We design the services provided to these residents to respond to their individual needs and to improve their quality of life.  This individualized assistance is available 24 hours a day and includes routine health-related services, which are made available and are provided according to the residents’  individual needs and state regulatory requirements.  Available services include:

 
§
general services, such as meals, activities, laundry and housekeeping;

 
§
support services, such as assistance with medication, monitoring health status, coordination of transportation, and coordination with physician offices;

 
§
personal care, such as dressing, grooming and bathing; and

 
§
a safe and secure environment with 24-hour access to assistance.

We also arrange access to additional services from third-party providers beyond basic housing and related services, including physical, occupational and respiratory therapy, home health, hospice, and pharmacy services.

Although a typical package of basic services provided to a resident includes meals, housekeeping, laundry and personal care, we accommodate the varying needs of our residents through the use of individual service plans and flexible staffing patterns.  Our rate structure for services is based upon the acuity, or level, of services needed by each resident and individual service plans are based on periodic assessments of the residents’ care needs.  Supplemental and specialized health-related services for those residents requiring 24-hour supervision or more extensive assistance with activities of daily living, are provided by third-party providers who are reimbursed directly by the resident or a third-party payer (such as Medicare, Medicaid or long-term care insurance).

Because we own rather than lease a significant number of our properties, we have the ability to add additional units onto existing properties without complications such as renegotiating leases with landlords.  Expansions are targeted where existing residences have demonstrated the ability to support increased capacity.  We continually evaluate ways to expand our portfolio of properties.  In 2012, we expanded one residence in Indiana, increasing it by 23 units.  See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Overview,” in this Annual Report for a discussion of our business strategies.

 
4


Servicemarks

We market and operate all of our residences under their own unique names.  We do not consider servicemarks to be important to our business.

The Merger Agreement
 
On February 25, 2013, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Aid Holdings, LLC, a Delaware limited liability company (“Aid Holdings”), and Aid Merger Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of Aid Holdings (“Aid Merger Sub”), providing for the merger of Aid Merger Sub with and into the Company (the “Merger”), 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.

Seasonality

While our business generally does not experience significant fluctuations from seasonality, winter months tend to result in more residents exiting our residences due to illnesses requiring hospitalization or skilled nursing facility services.  Approximately 23%, 24%, and 23% of our residence operating expenses came from property related costs, including utilities, in 2012, 2011, and 2010, respectively.  Because we operate in many “four season states”, utility costs associated with heating and cooling our residences tend to fluctuate by season.  Generally, our first and third quarter utility costs tend to exceed our second and fourth quarter utility expenses by approximately 25% to 35%, respectively.

Working Capital

It is not unusual for us to operate with a negative working capital position because our revenues are collected more quickly, often in advance, than our obligations are required to be paid.  This can result in a low level of current assets to the extent cash has been deployed in business development opportunities or used to repay longer term liabilities.  Because our borrowings under the $125 million revolving credit facility with U.S. Bank National Association, as administrative agent and collateral agent (“U.S. Bank”), and certain other lenders (the “U.S. Bank Credit Facility”) are due within the current year, the $108.0 million outstanding under the U.S. Bank Credit Facility was classified as a current liability in our consolidated financial statements.
 
 
5


Customers

Payments from residents (or their responsible parties) who pay us directly (“private pay”) comprised approximately 100%, 99% and 98% of our revenues in 2012, 2011 and 2010, respectively.  Our business is not materially dependent upon any single customer.  See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Medicaid Programs” below.

Government Regulation

State licensing agencies regulate certain of our operations and, where applicable, monitor our compliance with a variety of state and local laws governing licensure, changes of ownership, personal and nursing services, accommodations, construction, life safety, food service, and cosmetology.  Generally, the state oversight and monitoring of senior living operators has been less burdensome than experienced in the skilled nursing industry.  Areas most often regulated by these state agencies include:

 
§
qualifications of management and health care personnel;

 
§
minimum staffing levels;

 
§
dining services and overall sanitation;

 
§
personal care and nursing services;

 
§
assistance or administration of medication/pharmacy services;

 
§
residency agreements;

 
§
admission and retention criteria;

 
§
discharge and transfer requirements; and

 
§
resident rights.

Our residences may be subject to periodic unannounced surveys by state and other local government agencies to assess and assure compliance with the respective regulatory requirements.  A survey can also occur following a state’s receipt of a complaint regarding a residence.  If one of our residences is cited for alleged deficiencies by the respective state or other agencies, we may be required to implement a plan of correction within a prescribed timeframe.  Upon notification or receipt of a deficiency report, our regional and corporate teams assist the residence to develop, implement and submit an appropriate corrective action plan.  Most state citations and deficiencies are resolved through the submission of a plan of correction that is reviewed and approved by the state agency.  The survey team will conduct a re-visit to validate substantial compliance with the state rules and regulations.

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.

Health Privacy Regulations and Health Insurance Portability and Accountability Act

Our residences are subject to state laws to protect the confidentiality of our residents’ health information.  We have implemented procedures to meet the requirements of the state laws and we train our residence personnel on those requirements.

We are not a covered entity in respect of the Health Insurance Portability and Accountability Act of 1996, or HIPAA.  However, residences which electronically invoice state Medicaid programs are considered covered entities and are subject to HIPAA and its implementing regulations.  As of December 31, 2012, we electronically invoice the Medicaid program for one residence in the State of New Jersey. We use state provided software to reduce the complexity and risk in compliance with the HIPAA regulations.  HIPAA requires us to comply with standards for the exchange of health information at that residence and to protect the confidentiality and security of health data.  The Department of Health and Human Services has issued four rules that mandate the standards with respect to certain healthcare transactions and health information under HIPAA. The four rules pertain to:

 
§
privacy standards to protect the privacy of certain individually identifiable health information;
 
 
6

 
 
§
standards for electronic data transactions and code sets to allow entities to exchange medical, billing and other information and to process transactions in a more effective manner;

 
§
security of electronic health information privacy; and

 
§
use of a unique national provider identifier.

We believe we are in compliance with these rules as they currently affect our residence that electronically invoices state Medicaid programs.  We monitor compliance with health privacy rules including the HIPAA standards.  Should it be determined that we have not complied with the new standards, we could be subject to criminal penalties and civil sanctions.

Backlog

The nature of our business does not result in backlogs.
 
Competition

Although short-term data indicates limited new supply coming into the markets we serve, long-term, we expect to face increased competition from new market entrants as the demand for senior living grows.  Providers of senior living residences compete for residents primarily on the basis of quality of care, price, reputation, physical appearance of the residences, services offered, family preferences, physician referrals, and location. Some of our competitors operate on a not-for-profit basis or as charitable organizations.  In addition, we compete with home-based residential care, either provided by family members or other third parties.  As the general economy declines and unemployment increases, families are less able to afford our residences or are more willing or available to care for family members at home.

We compete directly with companies that provide living services to seniors as well as other companies that provide similar long-term care alternatives.  In most of the communities in which we operate, we face two or three competitors that offer senior living residences similar to ours in size, price and range of services offered.  In addition, we face competition from other providers in the senior living industry including companies that provide adult day care in the home, congregate care residences where residents elect the services to be provided, continuing care retirement centers on campus-like settings, and nursing homes that provide long-term care services.

We prefer to own our residences and, therefore, compete with various real estate investors, such as joint ventures, real estate investment trusts (“REITs”) and real estate developers, for land and facility purchases.  Generally, real estate investors purchase or construct senior living residences and enter into management agreements with operators.  In July 2008, the Health Care REIT provision of the REIT Improvement Diversification and Empowerment Act was passed as part of the Housing Assistance Act of 2008 allowing REITs to realize more value from their existing properties.  Real estate investment companies which may have substantially more resources and greater access to capital markets may compete with us for acquisitions in markets in which we operate or in which we look to operate.

The senior living industry, and specifically the independent living and assisted living segments, is large and fragmented.  It is characterized by numerous local and regional operators, although there are several national operators similar in size or larger than us.  The independent and senior living industry can be segregated into different market segments based upon the resources of the target population and the geographic area surrounding the operating residence.  We compete with the national operators, as well as a combination of local and regional companies, several of which may have substantially more resources than us, directly or indirectly in the middle-market, suburban bedroom communities that we target.
 
 
7


We believe that some markets, including some of the markets in which we operate, may have been overbuilt, in part because regulations and other barriers to entry into the assisted living industry are not substantial.  In addition, because the number of people who can afford to pay our daily resident fee is limited, the supply of senior living residences may outpace demand in some markets.  The impacts of such overbuilding include:

 
§
increased time to reach capacity at assisted living residences;

 
§
loss of existing residents to new residences;

 
§
pressure to lower or refrain from increasing rates;

 
§
competition for workers in tight labor markets; and

 
§
lower margins until excess units are absorbed.

In general, we believe that the markets in which we currently operate are capable of supporting only three or four senior living residences.

We believe that each local market is different, and our responses to the specific competitive environment in any market will vary.  However, if a competitor were to attempt to enter one of the markets in which we operate, we may be required to reduce our rates, provide additional services, or expand our residence to meet perceived additional demand.  We may not be able to compete effectively in markets that become overbuilt.

We believe our major competitive strengths are:

 
§
the size and breadth of our portfolio, and the depth of our experience in the senior living industry;

 
§
our ownership of 173 assisted living residences, or  82% of the total number of our residences, which increases our operating flexibility by allowing us to refurbish or expand residences to meet changing consumer demands without having to obtain landlord consent, and divest residences and exit markets at our discretion;

 
§
the staffing model of our residences which emphasizes the importance we place on delivering quality care to our residents, with a particular emphasis on preventative care and wellness; and

 
§
targeting communities based on their demographic profile, the average wealth of the population, and the cost of operating in the community.

Employees

As of December 31, 2012, we employed approximately 4,600 people, including approximately 450 registered and licensed practical nurses, 2,350 nursing assistants and 1,800 dietary, housekeeping, maintenance and other staff.

We have not been subject to union organization efforts at our residences.  To our knowledge, we have not been and are not currently subject to any other organizational efforts.

We compete with other healthcare providers for nurses and residence directors and with various industries for healthcare assistants and other lower-wage employees.  To the extent practicable, we avoid using temporary staff.  We have been subject to additional costs associated with the increasing levels of reference and criminal background checks that we have performed on our hired staff to ensure that they are suitable for the functions they will perform within our residences.  Our inability to control labor availability and costs could have a material adverse effect on our future operating results.

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. These measures resulted in approximately $9.9 million of additional salaries, wages and benefits in the second half of 2012 as compared to the first half of 2012.  The higher level of expenses is expected to continue for the foreseeable future.

 
8


Corporate Organization

Our corporate headquarters is located in Menomonee Falls, Wisconsin, where we have centralized various functions in support of our operations, including our human resources, legal, purchasing, internal audit, and accounting and information technology support functions.  At our corporate offices, senior management provides overall strategic direction, seeks development and acquisition opportunities, and manages the overall business.  The human resources function implements corporate personnel policies and administers wage and benefit programs.  We have dedicated clinical, accounting, legal, marketing, and risk management support groups for our operations.  Senior departmental staff are responsible for the development and implementation of corporate-wide policies pertaining to resident care, employee hiring, training and retention, marketing initiatives and strategies, risk management, residence maintenance, and project coordination.

Our corporate headquarters also oversees our operations in our geographic divisions.  A small staff in the office is responsible for overseeing all operational aspects of our residences in the respective divisions through teams of professionals located throughout the area.  The area team is responsible for compliance with standards involving resident care, rehabilitative services, recruitment and personnel matters, state regulatory requirements, marketing and sales activities, transactional accounting support, and participation in state associations.

Our operations are organized into a number of different direct and indirect wholly-owned subsidiaries primarily for legal purposes.  We manage our operations as a single unit.  Operating policies and procedures are substantially the same at each subsidiary.  Several of our subsidiaries own and operate a significant number of our total portfolio of residences.  No single residence generates more than 2.0% of our total revenues.

Legal Proceedings and Insurance

The provision of services in senior living residences involves an inherent risk of personal injury liability.  Senior living residences are subject to general and professional liability lawsuits alleging negligence of care and services and related legal theories.  Some of these lawsuits may involve substantial claims and can result in significant legal defense costs.  See “Item 3. Legal Proceedings” below.

We insure against general and professional liability risks in loss-sensitive insurance policies with affiliated and unaffiliated insurance companies with levels of coverage and self-insured retention levels that we believe are adequate based on the nature and risk of the business, historical experience, and industry standards.  We are responsible for the costs of claims up to self-insured limits determined by individual policies and subject to aggregate limits.

Available Information

We file our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and any amendments to those reports with the U.S. Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934.  A copy of any document we file with the SEC is available for review at the SEC's public reference room, 100 F Street, N.E., Washington, D.C. 20549. The SEC is reachable at 1-800-SEC-0330 for further information on the public reference room.  Our SEC filings are also available to the public on the SEC's Web site at http://www.sec.gov.

Our Internet address is www.alcco.com.  There we make available, free of charge, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and any amendments to those reports as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.  The information found on our website is not part of this or any other report we file with or furnish to the SEC.

 
9


ITEM 1A

If any of the risk factors described below develop into an actual event, it could have a material adverse effect on our business, financial condition, or results of operations.  These are not the only risks facing our company.  Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial could also adversely affect our business.

Risks Related to Our Announced Merger

There are a number of risks and uncertainties associated with the proposed Merger. Failure to complete the proposed Merger could negatively impact our business, financial condition, results of operations or stock price.

As discussed in “Item 1 – Business”, we have entered into an Agreement and Plan of Merger, dated as of February 25, 2013, with Aid Holdings and Aid Merger Sub, which contemplates 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.  A number of risks and uncertainties are associated with the proposed Merger. For example, the Merger may not be consummated in the time frame or manner currently anticipated or at all, as a result of several factors, including, among other things, the failure of one or more of the Merger Agreement’s closing conditions or litigation relating to the Merger. In addition, there can be no assurance that the approvals of our stockholders will be obtained, that certain state licenses and permits to operate the Company’s facilities will be obtained by Aid Holdings, that the other conditions to closing of the Merger will be satisfied or, to the extent permitted, waived or that other events will not intervene to delay or result in the termination of the Merger.  If the Merger is not effected on or before September 16, 2013, either Aid Holdings or the Company may terminate the Merger Agreement unless such party has breached in any material respect its obligations under the Merger Agreement in any manner that shall have substantially contributed to the failure of the Merger to be consummated on or before September 16, 2013.  If the proposed Merger is not completed, we will be subject to several risks, including:
 
·
our employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and hire key personnel and other employees;
 
·
customers and other parties with which we maintain business relationships may experience uncertainty about our future and seek alternative relationships with other parties or seek to alter their business relationships with us;
 
·
we may be required to pay a termination fee of $7,250,000 to Aid Holdings and reimburse up to $2,750,000 of Aid Holdings’ expenses if the Merger Agreement is terminated under certain circumstances;
 
·
we would not realize any of the anticipated benefits of having completed the proposed Merger;
 
·
the price of the Company’s Class A Common Stock may decrease to the extent that the current market price of such Class A Common Stock reflects an assumption that the Merger will be consummated; and
 
·
the Company could experience additional costs in refinancing the U.S. Bank Credit Facility.
 
The proposed Merger could cause disruptions to the Company’s business or business relationships, which could have an adverse impact on the Company’s results of operations, liquidity and financial condition.

Under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the proposed Merger, which could have an adverse impact on the Company’s results of operations, liquidity and financial condition. Such restrictions could adversely affect our ability to realize certain of our business strategies or to pursue opportunities that may arise prior to the closing of the Merger.  Furthermore, as a result of the proposed Merger, our management and Board of Directors have devoted and will continue to devote a significant amount of time and attention to the proposed Merger.  In addition, the Company has incurred, and will continue to incur, significant fees and expenses for professional services and other transaction costs in connection with the Merger, and many of these fees, expenses and costs are payable regardless of whether or not the Merger is consummated.  The Company’s relationships with customers, employees or suppliers may be adversely impacted following the announcement of the Merger Agreement, which may adversely affect its ability to hire and retain key personnel and its suppliers may seek alternative relationships with third parties or seek to alter their present business relationships with the Company.

Risks Relating to Our Business

Unfavorable economic conditions, such as recessions, high unemployment, and declining housing markets, adversely affect the ability of seniors to afford our resident fees and could cause occupancy, revenues, and earnings to decline.

Economic downturns limit the ability of seniors to afford our resident fees.  High unemployment levels may limit the ability of family members to provide financial support and may provide family members with the time necessary to take care of seniors in their homes.  Some residents depend on income from the sale of their homes or from other investments or financial support from family members in order to afford our resident fees.  Costs to seniors associated with senior living services are not generally reimbursable under government reimbursement programs such as Medicare and Medicaid.  Our occupancy rates and revenues could decline if we are unable to retain or attract seniors with sufficient income, assets or other resources required to pay the fees associated with senior living services.  If our average daily census in 2012 had decreased by one percentage point proportionately across all payer sources, we estimate our revenue would have decreased by approximately $2.3 million.
 
 
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We face numerous competitors and, if we are unable to compete successfully, we could lose occupancy, revenues and earnings.

Our business is highly competitive. We compete locally and regionally with other long-term care providers, including assisted and independent living providers, congregate care providers, home healthcare providers, skilled nursing facilities, and continuing care retirement communities, including both for-profit and not-for-profit entities.  We compete based on price, the types of services provided, quality of care, reputation, the age and appearance of residences and location.  Because there are relatively few barriers to entry in the senior living industry, competitors could enter the areas in which we operate with new residences or upgrade existing residences and offer residents more appealing residences with more amenities than ours at a lower cost.  The availability and quality of competing residences in the areas in which we operate can significantly influence occupancy levels in our residences.  The entrance of any additional competitors or the expansion of existing competing residences could result in our loss of occupancy, revenues and earnings.

If we fail to cultivate new or maintain existing relationships with resident referral sources in the markets in which we operate, our occupancy, revenues, and earnings may deteriorate.

Our ability to improve our overall occupancy, revenues and earnings depends on our reputation in the communities we serve and our ability to successfully market to our target population.  A large part of our marketing and sales efforts is directed towards cultivating and maintaining relationships with key community organizations who work with seniors, physicians and other healthcare providers in the communities we serve, and whose referral practices significantly affect the choices seniors make with respect to their long-term care needs.  If we are unable to successfully cultivate and maintain strong relationships with these community organizations, physicians and other healthcare providers, our occupancy, revenues and earnings could decline.

Events which adversely affect the perceived desirability, health or safety of our residences to current or potential residents could cause occupancy, revenues, and earnings to decline.

Our success depends upon maintaining our reputation for providing quality senior living services.  In addition, our residents live in close proximity to one another and may be more susceptible to disease than the general population.  Any event that raises questions about the quality of the management of one or more of our residences or that raises issues about the health or safety of our residents could cause occupancy, revenues, and earnings to decline.

Decisions by residents to terminate their residency agreements could adversely affect our occupancy revenues and earnings.

State regulations governing assisted living residences require a written residency agreement with each resident.  These regulations also require that residents have the right to terminate their residency agreements for any reason on reasonable notice.  Accordingly, many of our residency agreements allow residents to terminate their agreements upon 0 to 30 days’ notice.  If multiple residents terminate their residency agreements at or around the same time, our occupancy, revenues and earnings could decrease.

Labor costs comprise a substantial portion of our operating expenses.  An increase in wages, as a result of a shortage of qualified personnel or otherwise, or an increase in staffing requirements as a result of regulatory changes, could substantially increase our operating costs and reduce our earnings.

We compete with other healthcare providers for residence directors and nurses and with various industries for healthcare assistants and other employees.  A shortage of nurses and other trained personnel and general inflationary pressures may force us to enhance our wage and benefits packages in order to compete for and retain qualified personnel.  In order to supplement staffing levels, we periodically may be forced to use more costly temporary help from staffing agencies.  Because labor costs represent a substantial portion of our operating expenses, increases in wage rates could increase costs and reduce earnings.  In addition, regulatory changes could increase staffing requirements which could increase costs and reduce earnings.

 
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We may not be able to increase residents’ fees enough to cover increased energy, food or other costs, which could reduce our earnings.

Energy and food costs comprise a significant portion of our operating expenses.  We generally try to pass increases in energy, food and other costs on to our residents but may not be able to if residents are not able to afford the increased costs.  Increased energy, food, and other costs could reduce earnings, lower revenues from lower occupancy following rate increases, or both.

We may not be able to compete effectively in those markets where overbuilding exists and future overbuilding in markets where we operate could adversely affect our operations.

Overbuilding in the senior living industry in the late 1990s reduced occupancy and revenue rates at senior living residences.  This, combined with unsustainable levels of indebtedness, forced several senior living operators, including ALC, into bankruptcy.  The occurrence of another period of overbuilding could adversely affect our future occupancy and resident fee rates.
 
We operate in an industry that has an inherent risk of personal injury claims.  If one or more claims are successfully made against us, our financial condition and results of operations could be materially and adversely affected.

Personal injury claims and lawsuits can result in significant legal defense costs, settlement amounts and awards. In some states, state law may prohibit or limit insurance coverage for the risk of punitive damages arising from professional liability and general liability or litigation.  As a result, we may be liable for punitive damage awards in these states that either are not covered or are in excess of our insurance policy limits.  We insure against general and professional liability risks with affiliated and unaffiliated insurance companies with levels of coverage and self-insured retention levels that we believe are adequate based on the nature and risk of our business, historical experience and industry standards.  We are responsible for the costs of claims up to a self-insured limit determined by individual policies and subject to aggregate limits.  We accrue for self-insured liabilities based upon an actuarial projection of future self-insured liabilities, and have an independent actuary review our claims experience and attest to the adequacy of our accrual on an annual basis.  Claims in excess of our insurance may, however, be asserted and claims against us may not be covered by our insurance policies.  If a lawsuit or claim arises that ultimately results in an uninsured loss or a loss in excess of insured limits, our financial condition and results of operation could be materially and adversely affected.  Furthermore, claims against us, regardless of their merit or eventual outcome, could have a negative effect on our reputation and our ability to attract residents and could cause us to incur significant defense costs and our management to devote time to matters unrelated to the day-to-day operation of our business.

 
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We self-insure a portion of our general and professional liability, workers’ compensation, health and dental and certain other risks.

We insure against general and professional liability and workers’ compensation risks with levels of coverage and self-insured retention levels that we believe are adequate based upon the nature and risk of the business, historical experience, and industry standards.  In addition, for the majority of our employees, we self-insure our health and dental coverage.  Our costs related to our self-insurance are a direct result of claims incurred, some of which are not within our control.  Although we employ risk management personnel to manage liability risks, maintain safe workplaces, and manage workers’ compensation claims and we use a third-party provider to manage our health claims, any materially adverse claim experience could have an adverse effect on our business.

We operate in a regulated industry.  Failure to comply with laws or government regulation could lead to fines, penalties and loss of licenses.

The regulatory requirements for assisted living residence licensure generally prescribe standards relating to the provision of services, resident rights, qualification and level of staffing, employee training, administration and supervision of medication needs for the residents, and the physical environment and administration.  These requirements could affect our ability to expand into new markets, to expand our services and residences in existing markets and, if any of our presently licensed residences were to operate outside of its licensing authority, may subject us to penalties including closure of the residence.  Future regulatory developments as well as mandatory increases in the scope and severity of deficiencies determined by survey or inspection officials could cause our operations to suffer.
 
Compliance with the Americans with Disabilities Act, Fair Housing Act, and fire, safety and other regulations may require us to make unanticipated expenditures which could increase our costs and therefore adversely affect our earnings and financial condition.

Our residences are required to comply with the Americans with Disabilities Act, or ADA. The ADA generally requires that buildings be made accessible to people with disabilities.  We must also comply with the Fair Housing Act, which prohibits discrimination against individuals on certain bases if it would cause such individuals to face barriers in gaining residency in any of our residences.  In addition, we are required to operate our residences in compliance with applicable fire and safety regulations, building codes and other land use regulations and food licensing or certification requirements as they may be adopted by governmental agencies and bodies from time to time.  We may be required to make substantial expenditures to comply with those requirements.

We face periodic reviews, audits and investigations from federal and state government agencies and these audits could have adverse findings that may negatively impact our business.

We are subject to various governmental reviews, audits and investigations to verify our compliance with these programs and applicable laws and regulations.  An adverse review, audit or investigation could result in refunding, fines, penalties, loss of licenses and other sanctions, loss of our right to participate in one or more private payer networks, requirements to modify our operations and damage to our reputation.  We also are subject to potential lawsuits under a federal whistleblower statute designed to combat fraud and abuse in the healthcare industry.  These lawsuits can involve significant monetary awards to private plaintiffs who successfully bring these suits.

There are significant costs associated with pending governmental investigations and inquiries, and the ultimate outcome of these matters is uncertain.

We have been informed that ALC is the subject of an investigation by the SEC.  As part of this investigation, the SEC has issued subpoenas to us, and we have produced documents to the SEC as required on a number of topics, including ALC’s performance of its obligations under its former lease of certain facilities from Ventas Realty, Limited Partnership (“Ventas Realty”).  It is not possible to predict the outcome of the SEC investigation, which could include, among other things, the imposition of fines or the commencement of enforcement proceedings.  We have incurred substantial legal expenses to date in connection with the SEC investigation and will likely continue to do so during 2013.  We intend to cooperate fully with the SEC in its investigation.

Market conditions could restrict our ability to fill refurbished residences and expansion units.

Our business strategies include refurbishing under-performing residences and expanding high-performing residences to attract new residents.  If we fail to fill refurbished or expanded residences, it could adversely affect operating results.
 
 
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State regulations affecting the construction or expansion of healthcare providers could impair our ability to expand through construction and redevelopment.
 
Several states have established certificate of need processes to regulate the expansion of assisted living residences.  If additional states implement certificate of need or other similar requirements for assisted living residences, our failure or inability to obtain the necessary approvals, changes in the standards applicable to such approvals, and possible delays and expenses associated with obtaining such approvals, could adversely affect our ability to expand and, accordingly, to increase revenues and earnings.

Risks Relating to Our Indebtedness and Lease Arrangements
 
But for the most recent amendment to our U.S. Bank Credit Facility, we would not be in compliance with the maximum consolidated leverage ratio covenant of the U.S. Bank Credit Facility. If we do not consummate the transactions contemplated by the Merger Agreement or do not refinance the U.S. Bank Credit Facility, in either case, within the timeframe described in the most recent amendment, or we do not obtain waivers of or amendments to the covenants, our lenders could declare a default and demand repayment.
 
As of December 31, 2012, we had approximately $108.0 million of indebtedness outstanding under the U.S. Bank Credit Facility. This indebtedness is secured by the assets of, and is guaranteed by, certain of our subsidiaries. Our U.S. Bank Credit Facility includes financial covenants which require us to maintain compliance with certain financial ratios during the term of the agreement. Failure to comply with the financial covenants is an event of default under the U.S. Bank Credit Facility. In an event of default, the lenders have the right to accelerate repayment of all outstanding indebtedness, impose a higher default interest rate and take any and all action, at their sole option, to collect monies owed to them, including enforcing and foreclosing on their security interest. Although we continue to be current with all principal and interest payments with our lenders, we entered into the Waiver & Amendment No. 3 to Credit Agreement (the “Third Amendment”) with our lenders on December 31, 2012 to waive “Existing Alleged Defaults” under the U.S. Bank Credit Facility potentially arising from certain events and matters, and specifically to waive any noncompliance with the maximum consolidated leverage ratio of the U.S. Bank Credit Facility, 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 the 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 requirement that we 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.  As a result, 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.
 
The failure to satisfy any covenant in the Third Amendment or any other covenants in the U.S. Bank Credit Facility would constitute a breach of, and potentially a default under, the U.S. Bank Credit Facility and other borrowings subject to cross-default provisions ($23.8 million in total as of December 31, 2012). 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, 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. If our obligations under the U.S. Bank Credit Facility are accelerated, funding may not be available on favorable terms, if at all, or without potentially very substantial dilution to our stockholders.
 
Our U.S. Bank Credit Facility, existing mortgage loans and lease agreements contain covenants that restrict our operations.  Any default under such facilities, loans or leases could result in the acceleration of indebtedness, cross-defaults, or lease terminations, any of which would negatively impact our liquidity and our ability to grow our business and increase revenues.

Our U.S. Bank Credit Facility contains financial covenants and cross-default provisions that may inhibit our ability to grow our business and increase revenues. In some cases, indebtedness is secured by both a mortgage on a residence (or residences) and a guaranty by us.  In the event of a default under one of these scenarios, the lender could avoid judicial procedures required to foreclose on real property by declaring all amounts outstanding under the guaranty immediately due and payable and requiring us to fulfill our obligations to make such payments.  In addition, our leases contain financial and operating covenants and cross default provisions.  Breaches of certain lease covenants could give the landlord the right to require us to pre-pay future lease payments, write off our related assets, and replace us with new operators.  The realization of any of these scenarios could have an adverse effect on our financial condition and capital structure.  Further, because our mortgages and leases generally contain cross-default and cross-collateralization provisions, a default by us related to one residence could affect a significant number of residences and their corresponding financing arrangements and leases which could have a material adverse effect on our business as a whole.
 
 
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If we do not comply with the requirements prescribed within our leases or debt agreements pertaining to revenue bonds, we would be subject to financial penalties.
 
In connection with the construction or lease of some of our residences, we or our landlord issued federal income tax exempt revenue bonds guaranteed by the states in which they were issued.  Under the terms of the debt agreements relating to some of these bonds, we are required, among other things, to lease or make available at least 20% of the units of the projects to low or moderate income persons as defined in Section 142(d) of the Internal Revenue Code.  Non-compliance with these restrictions may result in an event of default and cause us to incur fines and other financial costs.  For revenue bonds issued pursuant to our lease agreements, an event of default would result in a default of the terms of the lease and could adversely affect our financial condition and results of operations.

If we do not comply with terms of the leases related to certain of our assisted living residences, or if we fail to maintain the residences, we could be faced with financial penalties and/or the termination of the lease related to the residence.

Certain of our leases require us to maintain a standard of property appearance and maintenance, operating performance and insurance requirements and require us to provide the landlord with our financial records and grant the landlord the right to inspect the residences.  Failure to meet the conditions of any particular lease could result in a default under such lease, which could lead to the loss of the right to operate on the premises, and financial and other costs.

Our indebtedness and long-term leases could adversely affect our liquidity and our ability to operate our business and our ability to execute our growth strategy.

Our level of indebtedness and our long-term leases could adversely affect our future operations or impact our stockholders for several reasons, including, without limitation:

 
·
we may have little or no cash flow apart from cash flow that is dedicated to the payment of any interest, principal or amortization required with respect to outstanding indebtedness and lease payments with respect to our long-term leases;

 
·
increases in our outstanding indebtedness, leverage and long-term leases will increase our vulnerability to adverse changes in general economic and industry conditions, as well as to competitive pressure; and

 
·
increases in our outstanding indebtedness may limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions, general corporate and other purposes.

Our ability to make payments of principal and interest on our indebtedness and to make lease payments on our leases depends upon our future performance, which will be subject to general economic conditions, industry cycles and financial, business and other factors affecting our operations, many of which are beyond our control.  If we are unable to generate sufficient cash flow from operations in the future to service our debt or to make lease payments on our leases, we may be required, among other things, to seek additional financing in the debt or equity markets, refinance or restructure all or a portion of our indebtedness, sell selected assets, reduce or delay planned capital expenditures, or delay or abandon desirable acquisitions.  Such measures might not be sufficient to enable us to service our debt or to make lease payments on our leases.  The failure to make required payments on our debt or leases or the delay or abandonment of our planned growth strategy could result in an adverse effect on our future ability to generate revenues and sustain profitability.  In addition, any such financing, refinancing or sale of assets might not be available on economically favorable terms to us.

Increases in market interest rates or various financial indices could significantly increase the costs of our debt and lease obligations, which could adversely affect our liquidity and earnings.

Borrowings under our revolving credit facility are exposed to variable interest rates.  In addition, some of our residences are leased under leases whose rental rates increase at their renewal dates based on financial indices such as the Consumer Price Index.  Increases in prevailing interest rates, or financial indices, could increase our payment obligations which would negatively impact our liquidity and earnings.
 
 
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Risks Relating to Our Class A Common Stock and Our Continuing Relationships with Thornridge Holdings Limited
 
Thornridge Holdings Limited has the ability to control the direction of our business.  The concentrated ownership of our Class B Common Stock, which has ten votes per share, makes it difficult for holders of our Class A Common Stock to influence significant corporate decisions.

As of March 8, 2013, Thornridge Holdings Limited (“Thornridge Holdings”) owned approximately 94% of the outstanding shares of our Class B Common Stock and approximately 2% of the outstanding shares of our Class A Common Stock, which together represents approximately 56% of the total voting power of our common stock.  Accordingly, Thornridge Holdings generally has the ability to influence or control matters requiring stockholder approval, including the nomination and election of directors and the determination of the outcome of corporate transactions such as mergers, acquisitions and asset sales.  Our chairman, Mr. David J. Hennigar, is chairman, chief executive officer and a director of Thornridge Holdings.  Mr. Hennigar disclaims beneficial ownership of the shares held by Thornridge Holdings.  In addition, the disproportionate voting rights of our Class B Common Stock may make us a less attractive takeover target.  In connection with the execution of the Merger Agreement, Thornridge Holdings entered into a voting agreement pursuant to which Thornridge Holdings has agreed to, among other things, vote all of its shares of Company Stock in favor of the transactions contemplated under the Merger Agreement and vote against any alternative acquisition proposals.  The voting agreement terminates upon the termination of the Merger Agreement.

Our corporate governance documents may delay or prevent an acquisition of us that stockholders may consider favorable.

Our amended and restated articles of incorporation and amended and restated bylaws include a number of provisions that may deter hostile takeovers or changes of control. These provisions include:

 
·
the authority of our Board of Directors to issue shares of preferred stock and to determine the price, rights, preferences, and privileges of these shares, without stockholder approval;

 
·
all stockholder actions must be effected at a duly called meeting of stockholders or by the unanimous written consent of stockholders, unless such action or proposal is first approved by our Board of Directors;

 
·
special meetings of the stockholders may be called only by our Board of Directors;

 
·
stockholders are required to give advance notice of business to be proposed at a meeting of stockholders; and

 
·
cumulative voting is not allowed in the election of our directors.
 
UNRESOLVED STAFF COMMENTS

None.
 
 
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PROPERTIES
 
As of December 31, 2012, our 211 residences were located in 20 states, and contain 9,348 units.  We own 173 residences and lease 38 residences pursuant to operating leases.

Our senior living operations are outlined in the following table:

   
Owned
   
Leased from Others
 
Total Residences Under
Operation
 
   
 
Number
   
Encumbered(1)
   
Units
   
Number
   
Units
   
Number
   
Units
 
Texas
    34       17       1,386       7       277       41       1,663  
Indiana
    21       12       963       2       78       23       1,041  
Washington
    13             588       8       308       21       896  
Ohio
    15       4       623       5       191       20       814  
Wisconsin
    12       8       712                   12       712  
Oregon
    10       7       347       4       158       14       505  
Iowa
    6       2       434       1       35       7       469  
Pennsylvania
    11       10       432                   11       432  
Arizona
    7       2       324       2       76       9       400  
South Carolina
    10       7       394                   10       394  
Idaho
    5       1       231       4       148       9       379  
Nebraska
    5       2       168       4       156       9       324  
Georgia
    5             289                   5       289  
New Jersey
    7       1       273       1       39       8       312  
Louisiana
    4       2       215                   4       215  
Michigan
    4       3       180                   4       180  
Alabama
    1             164                   1       164  
Minnesota
    1             60                   1       60  
Kentucky
    1       1       55                   1       55  
Florida
    1             44                   1       44  
Total
    173       79       7,882       38       1,466       211       9,348  
(1)  Certain of our properties are pledged as collateral under debt obligations.  See Note 11 to our consolidated financial statements.

Corporate Offices

We own our corporate headquarters which is located in Menomonee Falls, Wisconsin.

LEGAL PROCEEDINGS

ALC is involved in various unresolved legal matters that arise in the normal course of operations, the most prevalent of which relate to commercial contracts and premises and professional liability matters.  Although the outcome of these matters cannot be predicted with certainty and favorable or unfavorable resolutions may affect the results of operations on a quarter-to-quarter basis, we believe that the outcome of such legal and other matters will not have a material adverse effect on our consolidated financial position, results of operations, or liquidity.  See “Legal Proceedings and Insurance” in Item 1 of this report.

In addition, we are involved in the following legal matters:

On May 29, 2012, the Board of Directors terminated Ms. Laurie Bebo’s employment as President and CEO for cause.  On June 29, 2012, Ms. Bebo initiated an arbitration proceeding against ALC disputing the existence of cause for her termination and alleging that she is entitled to more than $2.4 million in severance pay and other termination benefits because her termination was without cause.  That arbitration is being administered by the American Arbitration Association.  In addition, ALC learned, on or around October 15, 2012, that on July 26, 2012, Ms. Bebo filed a purported Sarbanes-Oxley whistleblower complaint with the Occupational Safety and Health Administration of the U.S. Department of Labor.  Ms. Bebo’s whistleblower complaint alleges that her termination was in retaliation for her purported suggestion that ALC disclose that the reason for the delay in its earnings report and earnings call, announced on May 3, 2012, was the litigation filed against ALC by Ventas Realty on April 26, 2012 (which litigation was dismissed with prejudice as part of a transactional resolution with Ventas Realty in June 2012).  ALC has responded to Ms. Bebo’s claim in arbitration, denying the material allegations of Ms. Bebo’s demand.  ALC has also responded to Ms. Bebo’s whistleblower complaint, asserting that Ms. Bebo’s complaint is legally and factually without merit.  ALC will continue to vigorously defend against Ms. Bebo’s arbitration demand and the whistleblower complaint.  ALC determined not to file a counterclaim in the arbitration, but retains the ability to file claims against Ms. Bebo, including for matters relating to her conduct and performance in her capacity as CEO of ALC.
 
 
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On June 29, 2012, a lawsuit captioned Laurie Bebo v. Assisted Living Concepts, Inc. was filed in Waukesha County Circuit Court, State of Wisconsin.  The lawsuit seeks an order requiring ALC to produce certain company records previously requested by Ms. Bebo as a director of ALC and a judgment requiring ALC to indemnify Ms. Bebo for all expenses incurred in connection with ALC’s internal investigation relating to the Ventas lease as well as to advance Ms. Bebo all expenses incurred by her in connection with the investigation.  On October 19, 2012, the court granted ALC’s motion to dismiss Ms. Bebo’s claim for access to company records and allowed the claims for indemnification.  ALC will continue to vigorously defend against Ms. Bebo’s claims.

On August 2, 2012, ALC was informed by the SEC that the SEC staff is conducting an investigation relating to ALC.  As part of this investigation, the SEC issued a subpoena to ALC.  The first subpoena was subsequently withdrawn and replaced by a new subpoena requesting additional information.  In compliance with the subpoenas, ALC has produced to the SEC documents on a number of topics, including, among others, compliance with occupancy covenants in the now-terminated lease with Ventas Realty and leasing of units for employee use.  ALC intends to cooperate fully with the SEC in its investigation.

On August 29, 2012, a putative securities class action lawsuit was filed against ALC and Ms. Bebo on behalf of individuals and entities who allegedly purchased or otherwise acquired ALC’s Class A Common Stock between March 12, 2011 and August 6, 2012.  The complaint, captioned Robert E. Lifson, Individually and On Behalf of All Others Similarly Situated, v. Assisted Living Concepts, Inc. and Laurie A. Bebo, 2:12-cv-00884, was filed in the United States District Court for the Eastern District of Wisconsin.  On November 14, 2012, the court approved the Pension Trust for Operating Engineers as lead plaintiff in the action and also appointed lead counsel for the putative class.  An amended complaint was filed on February 15, 2013, among other things changing the start date of the class period to March 4, 2011.  The lawsuit, as amended, asserts that ALC did not accurately disclose occupancy data, falsely touted the success of its “private pay” business model, and falsely reported that it was in compliance with its former lease with Ventas Realty, and seeks damages for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, plus an award of plaintiff’s legal fees and expenses with respect to the litigation. ALC intends to vigorously defend itself against these claims.

On September 13, 2012, a lawsuit was filed derivatively by an alleged stockholder of ALC against certain of ALC’s current and former executive officers and directors and ALC, as nominal defendant.  The complaint is captioned George Passaro, Individually and Derivatively on Behalf of Assisted Living Concepts, Inc. v. Laurie A. Bebo, et al., Case No. 12CV010106, and was filed in the Milwaukee County Circuit Court for the State of Wisconsin.  The complaint alleges that the individual defendants, which include all of ALC’s directors at the filing date of the lawsuit, certain senior officers and Ms. Bebo, breached their fiduciary duties to exercise good faith to ensure that ALC was operated in a diligent, honest and prudent manner, and to exercise good faith in taking appropriate action to prevent and correct certain issues relating to ALC’s legal and regulatory compliance.  The lawsuit seeks damages and other relief in favor of ALC and the plaintiff's costs and disbursements with respect to the litigation.  On February 15, 2013, the defendants filed motions to dismiss the complaint.  ALC believes that this lawsuit is without merit.

On or around October 19, 2012, ALC’s Board of Directors received a demand letter from another potential derivative plaintiff, David Raul, asserting matters similar to those asserted in the Passaro complaint.  The Board of Directors has determined to defer detailed consideration of Mr. Raul’s demand until a ruling on the motion to dismiss the Passaro action and has so informed Mr. Raul.

On December 21, 2012, a lawsuit was filed derivatively by an alleged stockholder of ALC against certain of ALC’s current and former executive officers and directors and ALC, as nominal defendant. The complaint is captioned Guy Somers, Derivatively on Behalf of Assisted Living Concepts, Inc. v. Laurie A. Bebo, et al., Case No. A-12-674054-C, and was filed in the Eighth Judicial District Court of the State of Nevada in and for Clark County.  The substantive allegations of the Somers complaint, as originally filed, were similar to the allegations in the Passaro litigation described above, and focused upon ALC’s alleged failure to comply with state regulatory and licensing requirements bearing upon the operation of assisted living facilities, and the defendants’ alleged failure to take action to correct the claimed regulatory noncompliance.  Unlike the Passaro complaint, which purports to allege only a breach of the fiduciary duty of good faith, the original Somers complaint purported to allege four causes of action, for breach of fiduciary duty, contribution and indemnification, waste of corporate assets, and unjust enrichment.
 
 
18

 
On February 28, 2013, the Somers plaintiff filed an amended complaint.  While repeating the substantive allegations contained in the original complaint, the amended complaint added new claims, purportedly asserted on a class action basis, against ALC’s directors and certain newly added defendants arising from the proposed sale of ALC to affiliates of TPG Capital, L.P., announced on February 26, 2013 (the “Proposed Sale”).  The amended complaint is captioned Guy Somers, Derivatively on Behalf of Assisted Living Concepts, Inc. and on Behalf of all Others Similarly Situated v. Laurie A. Bebo, et al., and names as additional defendants TPG Capital, L.P., Aid Holdings, LLC and AID Merger Sub, LLC.  The newly asserted claims allege that (i) certain of ALC’s directors breached their fiduciary duties in connection with the Proposed Sale, and (ii) TPG Capital, L.P. and its affiliates aided and abetted the claimed fiduciary breaches by the aforementioned directors.  The relief sought in the amended complaint on behalf of the purported shareholder class includes, among other things, an injunction prohibiting the consummation of the Merger and attorneys’ costs and fees.  ALC believes that this lawsuit is without merit.
 
On March 4, 5, and 6, 2013, three additional complaints, all purportedly asserted on a class action basis, were filed in the Eighth Judicial District Court of the State of Nevada in and for Clark County, captioned Scott Simpson, on behalf of himself and all others similarly situated v. Assisted Living Concepts, Inc., et al., Case No. A-13-677683-C, David Raul as Custodian for Malka Raul Utma NY, on behalf of itself and all others similarly situated v. Assisted Living Concepts, et al., Case No. A-13-677797-C, and Elizabeth Black, Individually and on behalf of all others similarly situated v. Assisted Living Concepts, Inc., et al., Case No. A-13-677838-C, respectively.  Each of these complaints asserts claims that ALC’s directors breached their fiduciary duties to ALC stockholders in connection with the Proposed Sale.  These complaints further claim that TPG Capital, L.P., Aid Holdings, LLC and Aid Merger Sub, LLC aided and abetted those alleged breaches of fiduciary duties.
 
Also on March 6, 2013, another putative class action complaint was filed in the Eighth Judicial District Court of the State of Nevada in and for Clark County, captioned The Joel Rosenfeld IRA, On Behalf of Itself and All Others Similarly Situated v. Assisted Living Concepts, Inc., et al., Case No. A-13-677902-C, against ALC and certain of its directors.  This complaint alleges the directors breached their fiduciary duties in connection with the Proposed Sale.
 
The plaintiffs in the Simpson, Raul, Black and Rosenfeld actions seek equitable relief, including an injunction preventing the consummation of the Proposed Sale, rescission or rescissory damages in the event the Proposed Sale is consummated, and an award of attorneys’ and other fees and costs.  ALC believes that these lawsuits are without merit.

MINE SAFETY DISCLOSURES

Not applicable.

EXECUTIVE OFFICERS OF THE REGISTRANT
 
 
19


Listed below are the executive officers of ALC, together with their ages, positions and business experience for the past five years.  All executive officers hold office at the pleasure of the Board of Directors.

Name
 
Age
 
Position
Charles H. Roadman II, M.D.
 
69
 
President and Chief Executive Officer
John Buono
 
49
 
Senior Vice President, Chief Financial Officer and Treasurer
Walter A. Levonowich
 
56
 
Vice President and Controller
Mary T. Zak-Kowalczyk
 
49
 
Vice President and  Corporate Secretary

Charles H. Roadman II, M.D. Dr. Roadman has served as a director of the Company since 2006 and became ALC's interim President and Chief Executive Officer in May 2012 in connection with the departure of Laurie A. Bebo. Dr. Roadman is a retired President and Chief Executive Officer of the American Health Care Association (1999 to 2004) and former Surgeon General of the U.S. Air Force (1996 to 1999). Prior to November 10, 2006, he was a director of Extendicare. Dr. Roadman serves as a director and advisor on a number of private corporate boards.
 
John Buono.  From 2005 until joining ALC in October 2006, Mr. Buono was a consultant to Wind Lake Solutions, Inc., an engineering consulting firm.  From 2003 to 2005, Mr. Buono was the Chief Financial Officer and Secretary of Total Logistics, Inc., a publicly-owned provider of logistics services and manufacturer of refrigerator casements, and from 1988 until 2001,  Mr. Buono was the Corporate Director-Accounting and Assistant Treasurer of Sybron International, Inc., a publicly-owned manufacturer of products for the laboratory and dental industries.

Walter A. Levonowich.  Mr. Levonowich has been Vice President and Controller of ALC since February 2005.  Prior to February 2005, he held a number of positions in various financial capacities with EHSI and its subsidiaries, including Vice President of Reimbursement Services and Vice President of Accounting.

Mary T. Zak-Kowalczyk. Ms. Zak-Kowalczyk was appointed Vice President and Corporate Secretary in December 2010.  Prior to this appointment, Ms. Zak-Kowalczyk had been Senior Corporate Counsel for ALC since May 2006.  From 2000 to 2006, she was employed by EHSI as corporate counsel and advised EHSI’s skilled nursing, assisted living and independent living operations on a variety of legal matters.
 
 
20

 
PART II
 
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Effective March 16, 2009, we implemented a one-for-five reverse stock split of our Class A Common Stock, par value $0.01 per share, and Class B Common Stock, par value $0.01 per share, and on May 20, 2011, we implemented a two-for-one stock split of our Class A Common Stock and Class B Common Stock.  All share amounts, stock prices, and per share data in this report have been adjusted to reflect the stock splits.

On November 10, 2006, we issued 23,017,266 shares of Class A Common Stock, and 4,711,374 shares of Class B Common Stock, in connection with the Separation.

Our Class A Common Stock is listed and began trading on the New York Stock Exchange under the symbol “ALC” on November 10, 2006.  The following table shows the high and low sales prices of our Class A Common Stock during the last two fiscal years as reported by the NYSE.

   
High
   
Low
 
2012:
           
First quarter
  $ 17.69     $ 14.57  
Second quarter
  $ 20.33     $ 12.51  
Third quarter
  $ 15.10     $ 6.93  
Fourth quarter
  $ 9.80     $ 7.41  
                 
2011:
               
First quarter
  $ 19.60     $ 15.36  
Second quarter
  $ 19.61     $ 15.94  
Third quarter
  $ 17.21     $ 11.16  
Fourth quarter
  $ 15.22     $ 12.00  

The Company paid the following dividends per share on the Class A and Class B Common Stock:

   
2012
   
2011
 
First quarter
  $ 0.10     $  
Second quarter
  $ 0.10     $ 0.10  
Third quarter
  $     $ 0.10  
Fourth quarter
  $     $ 0.10  
    $ 0.20     $ 0.30  

The Company is prohibited from paying any dividends pursuant to the terms of the Merger Agreement and the U.S. Bank Credit Facility. Subject to the foregoing sentence, the declaration and payment of future dividends will be at the discretion of our Board of Directors and will depend on a number of factors including our financial condition, operating results, current and anticipated cash needs, plans for expansion, contractual restrictions with respect to payment of dividends and other factors deemed relevant by the Board of Directors.
 
The closing sale price of our Class A Common Stock as reported on the NYSE on March 8, 2013, was $11.86 per share.  As of that date there were 306 holders of record.

Our Class B Common Stock is neither listed nor publicly traded.  On March 8, 2013, there were 59 holders of record of our Class B Common Stock.

The relative rights of the Class A Common Stock and the Class B Common Stock are substantially identical in all respects, except for voting rights, conversion rights and transferability.  Each share of Class A Common Stock entitles the holder to one vote and each share of Class B Common Stock entitles the holder to ten votes with respect to each matter presented to our stockholders on which the holders of common stock are entitled to vote.

Each share of Class B Common Stock is convertible at any time and from time to time at the option of the holder thereof into 1.075 shares of Class A Common Stock. In addition, any shares of Class B Common Stock transferred to a person other than a permitted holder (as described in our amended and restated articles of incorporation) of Class B Common Stock will automatically convert into shares of Class A Common Stock on a 1:1.075 basis upon any such transfer. Shares of Class A Common Stock are not convertible into shares of Class B Common Stock.
 
 
21


A reconciliation of our outstanding shares since December 31, 2009  is as follows:

     
Class A
Common
Stock
   
Class B
Common
Stock
   
Treasury
Stock
 
December 31, 2009
 
    20,097,348       3,057,300       4,697,702  
 
Conversion of Class B to Class A
    17,688       (16,680 )      
 
Repurchase of Class A Common Stock
    (184,970 )           184,970  
 
Issuance of shares for stock options
    4,000              
December 31, 2010
 
    19,934,066       3,040,620       4,882,672  
 
Conversion of Class B to Class A
    129,882       (120,830 )      
 
Repurchase of Class A Common Stock
    (49,200 )           49,200  
 
Issuance of shares for stock options
    34,338              
December 31, 2011
 
    20,049,086       2,919,790       4,931,872  
 
Conversion of Class B to Class A
    23,423       (21,794 )      
 
Repurchase of Class A Common Stock
                 
 
Issuance of shares for stock options
                 
December 31, 2012
      20,072,509       2,897,996       4,931,872  

ISSUER PURCHASES OF EQUITY SECURITIES

The following summary of repurchases of Class A Common Stock during the fourth quarter of 2012 is provided in compliance with Item 703 of Regulation S-K.

Period
 
(a)
Total Number of
Shares Purchased (1)
   
(b)
Average Price Paid
Per Share
   
(c)
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
   
(d)
Maximum Number
(or Approximate
Dollar Value) of
Shares that May Yet
Be Purchased
Under the Plans or
Programs (1)
 
October 1, 2012 to October 31, 2012
                    $ 15,000,000  
November 1, 2012 to November 30, 2012
                    $ 15,000,000  
December 1, 2012 to December 31, 2012
                    $ 15,000,000  
Total
                    $ 15,000,000  
(1)  Consists of shares authorized for repurchase under the extended and expanded share repurchase program approved by the Board of Directors on August 9, 2010 under which ALC was authorized to purchase up to $15 million of its outstanding shares of Class A Common Stock through August 9, 2011 (exclusive of fees).  On May 2, 2011, the Board of Directors extended the stock repurchase plan by resetting the authorized amount of repurchases to $15 million and removed the expiration date.  Prior to the May 2, 2011 Board action there was $13.3 million remaining under the repurchase program.  The repurchase program will no longer be subject to an annual expiration date and will only expire upon completion of stock repurchases totaling $15 million or by action of the Board.  However, the Company is prohibited from repurchasing any shares of capital stock pursuant to the terms of the Merger Agreement and the U.S. Bank Credit Facility.

Performance Graph

The following Performance Graph shows the changes for the period beginning December 31, 2007 and ended December 31, 2012 in the value of $100 invested in: (1) ALC’s Class A Common Stock; (2) the Standard & Poor’s Broad Market Index (the “S&P 500”); and (3) the common stock of the peer group (as defined below) of companies, whose returns represent the arithmetic average for such companies.  The values shown for each investment are based on changes in share price and assume the immediate reinvestment of any cash dividends.

 
22


COMPARISON OF CUMULATIVE TOTAL RETURN SINCE DECEMBER 31, 2007
AMONG ASSISTED LIVING CONCEPTS, INC.,
THE S&P 500 INDEX, AND THE PEER GROUP

The following graph assumes $100 invested at the beginning of the measurement period in our Class A Common Stock, the S&P 500 and the peer group, with reinvestment of dividends, and was plotted using the following data:

After reviewing publicly filed documents of various companies, ALC determined that a peer group consisting of Brookdale Senior Living, Inc., Capital Senior Living Corporation, Emeritus Corporation, Five Star Quality Care, Inc. and Sunrise Assisted Living, Inc. most closely matches ALC in terms of market capitalization and market niche.

SELECTED FINANCIAL DATA

The following selected financial data as of and for each of the five years in the period ended December 31, 2012 has been derived from our audited consolidated financial statements.  The selected financial data does not purport to indicate results of operations as of any future date or for any future period.  The selected financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and related notes included elsewhere in this report.

The consolidated financial statements of ALC have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Management’s most significant estimates include measurement of acquired assets and liabilities in business combinations, valuation of assets and determination of asset impairment, self-insured liabilities for general and professional liability, workers’ compensation and health and dental claims, valuation of conditional asset retirement obligations, and valuation of deferred tax assets. Actual results could differ from those estimates.
 
 
23

 
The financial information presented below may not reflect what our results of operations, financial position and cash flows will be in the future.
 
   
Years Ended December 31,
 
   
2012
     
2011
     
2010
     
2009
     
2008
 
          [----------reclassified1----------]  
Income Statement Data:
 
(In thousands, except per share data)
 
Revenues
$
 228,397
   
$
 234,452
   
$
 233,128
   
$
 228,723
   
$
 231,576
 
Expenses:
                                     
Residence operations (exclusive of depreciation and amortization and residence lease expense shown below)
 
154,194
     
136,659
     
139,689
     
142,048
     
150,645
 
General and administrative
 
19,822
     
13,361
     
15,080
     
13,515
     
12,789
 
Residence lease expense
 
13,369
     
17,686
     
19,846
     
20,044
     
19,910
 
Lease termination and settlement
 
37,430
     
     
     
     
 
Depreciation and amortization
 
24,915
     
23,103
     
22,806
     
21,219
     
18,333
 
Impairment of intangibles
 
8,650
     
     
     
     
 
Goodwill impairment
 
     
     
     
16,315
     
 
Impairment of long-lived assets
 
3,500
     
     
     
148
     
 
Transaction costs
 
      1,046
     
      —
     
    —
     
    —
     
 
Total operating expenses
 
262,926
     
190,809
     
197,421
     
213,289
     
201,677
 
(Loss)/income from operations
 
(34,529
)
   
43,643
     
35,707
     
15,434
     
29,899
 
Other expense:
                                     
Gain on sale of securities
 
257
     
956
     
23
     
     
 
Other-than- temporary investments impairment
 
     
     
(2,026
)
   
     
 
Interest income
 
9
     
12
     
11
     
54
     
614
 
Interest expense
 
(8,143
)
   
(7,872
)
   
(7,782
)
   
(7,343
)
   
(7,149
)
Write off of deferred financing costs
 
(1,137
)
   
(279
)
   
     
     
 
(Loss)/income from continuing operations before income taxes
 
(43,543
)
   
36,460
     
25,933
     
8,145
     
23,364
 
Income tax benefit/(expense)
 
17,418
     
(12,100
)
   
(9,449
)
   
(7,343
)
   
(8,652
)
Net (loss)/income from continuing operations
 
(26,125
)
   
24,360
     
16,484
     
802
     
14,712
 
Net (loss)/income from discontinued operations
 
     
     
     
(957
)
   
(389
)
Net (loss)/income
$
 (26,125
)
 
$
 24,360
   
$
 16,484
   
$
(155
)
 
$
 14,323
 
Per share data:
                                     
Basic earnings per common share:
                                     
(Loss)/income from continuing operations
$
(1.14
)
 
$
1.06
   
$
0.71
   
$
0.03
   
$
0.59
 
Loss from discontinued operations
 
     
     
     
(0.04
)
   
(0.02
)
Net (loss)/income
$
 (1.14
)
 
$
 1.06
   
$
 0.71
   
$
 (0.01
)
 
$
 0.57
 
Diluted earnings per common share:
                                     
(Loss)/income from continuing operations
$
(1.14
)
 
$
1.05
   
$
0.70
   
$
0.03
   
$
0.58
 
Loss from discontinued operations
 
     
     
     
(0.04
)
   
(0.02
)
Net (loss)/income
$
 (1.14
)
 
$
 1.05
   
$
 0.70
   
$
 (0.01
)
 
$
 0.56
 
                                       
Cash dividends paid per common share
$
0.20
   
$
0.30
   
$
   
$
   
$
 

   
Years Ended December 31,
 
   
2012
   
2011
   
2010
   
2009
   
2008
 
        [----------reclassified1----------]  
Balance Sheet Data (at end of period):
 
(In thousands)
 
Cash and cash equivalents
  $ 10,182     $ 2,652     $ 13,364     $ 4,360     $ 19,905  
Property and equipment
    481,913       430,733       437,303       415,454       413,149  
Total assets
    515,769       464,053       485,104       455,369       498,621  
Total debt
    181,715       88,241       132,110       121,737       147,756  
Stockholders’ equity
    277,643       307,720       289,259       272,971       279,739  

(1) Reflects the reclassification of units previously classified as continuing operations to discontinued operations.
 
 
24

 
 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.
 
 
25

 
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.
 
 
26

 
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.
 
 
27

 
 
·
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.
 
 
28

 
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.
 
 
29


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 which we had previously leased from Ventas Realty and MTD.
 
 
30

 
Business Overview

Revenues

For the years ended December 31, 2012, 2011 and 2010, approximately 100%, 99% and 98%, respectively, of our revenues were generated from private pay sources.  Residents are charged an accommodation fee that is based on the type of accommodation they occupy and a service fee that is based upon their assessed level of care.  We generally offer studio, one-bedroom and two-bedroom accommodations.  The accommodation fee is based on prevailing market rates of similar senior living accommodations.  The service fee is based upon periodic assessments, which include input of the resident and the resident’s physician and family and establish the additional hours of care and service provided to the resident.  We offer various levels of care for our residents who require less or more frequent and intensive care or supervision.  For the years ended December 31, 2012, 2011 and 2010 approximately 75%, 76% and 76%, respectively, of our private pay revenue was derived from accommodation fees with the balance derived from service fees.  Both the accommodation and level of care service fees are charged on a per day basis, pursuant to residency agreements.

Medicaid rates are generally lower than rates earned from private payers.  Therefore, we consider our private pay mix an important performance indicator.
 
Residence Operations Expenses
 
For all residences, residence operations expense percentages consisted of the following:

   
2012
   
2011
   
2010
 
Wage and benefit costs
    62 %     60 %     60 %
Property related costs
    23       24       23  
Other operating costs
    15       16       17  
Total
    100 %     100 %     100 %

The largest component of our residence operations expense consist of wages and benefits and property related costs which include utilities, property taxes, and building maintenance related costs.  Other operating costs include food, advertising, insurance, and other operational costs related to providing services to our residents.  Wage and benefit costs are generally variable (with the exception of minimum staffing requirements as provided from state to state) and can be adjusted with changes in census.  Property related costs are generally fixed while other operating costs are a mix of fixed (e.g., insurance) and variable costs (e.g.,  food).

Key Performance Indicators
 
We manage our business by monitoring certain key performance indicators.  We believe our most important key performance indicators are:
 
Census
 
Census is defined as the number of units rented at a given time.
 
Average Daily Census
 
Average daily census, or ADC, is the sum of rented units for each day over a period of time, divided by the number of days in that period.
 
Occupancy
 
Occupancy is measured as the percentage of average daily census relative to the total number of units available for occupancy in the period.
 
 
31

 
Private Pay Mix
 
Private pay occupancy mix is the measure of the percentage of private or non-Medicaid census.  Private pay revenue mix is the measure of the percentage of private or non-Medicaid revenues.  We focus on maintaining high private pay occupancy and revenue mixes.

Average Revenue Rate
 
The average revenue rate represents the average daily revenues earned from accommodation and service fees provided to residents.  The daily revenue rate is calculated by dividing aggregate revenues earned by the ADC in the corresponding period.

Adjusted EBITDA and Adjusted EBITDAR
 
Adjusted EBITDA is defined as net income from operations before income taxes, interest expense net of interest income, depreciation and amortization, non-cash equity based compensation expense, transaction costs and certain non-cash, gains and losses, including disposal of assets, impairment of goodwill and other long-lived assets, gains and losses on sales of securities, and impairment of investments.  Adjusted EBITDAR is defined as Adjusted EBITDA before rent expenses incurred for leased assisted living properties.  Adjusted EBITDA and Adjusted EBITDAR are not measures of performance under accounting principles generally accepted in the United States of America, or GAAP.  We use Adjusted EBITDA and Adjusted EBITDAR as key performance indicators and Adjusted EBITDA and Adjusted EBITDAR expressed as a percentage of total revenues as a measurement of margin.
 
We understand that EBITDA and EBITDAR, or derivatives of these terms, are customarily used by lenders, financial and credit analysts, and many investors as a performance measure in evaluating a company’s ability to service debt and meet other payment obligations or as a common valuation measurement in the long-term care industry.  Moreover, our U.S. Bank Credit Facility contains covenants in which a form of EBITDA is used as a measure of compliance, and we anticipate a form of EBITDA will be used in covenants in any new financing arrangements that we may establish.  We believe Adjusted EBITDA and Adjusted EBITDAR provide meaningful supplemental information regarding our core results because these measures exclude the effects of non-operating factors related to our capital assets, such as the historical cost of the assets.
 
We report specific line items separately and exclude them from Adjusted EBITDA and Adjusted EBITDAR because such items are transitional in nature and would otherwise distort historical trends.  In addition, we use Adjusted EBITDA and Adjusted EBITDAR to assess our operating performance and in making financing decisions.  In particular, we use Adjusted EBITDA and Adjusted EBITDAR in analyzing potential acquisitions and internal expansion possibilities.  Adjusted EBITDAR performance is also used in determining compensation levels for our senior executives.  Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as substitutes for net income, cash flows from operating activities, and other income or cash flow statement data prepared in accordance with GAAP, or as measures of profitability or liquidity.  In this report, we present Adjusted EBITDA and Adjusted EBITDAR on a consistent basis from period to period, thereby allowing for comparability of operating performance.

Review of Key Performance Indicators

In addition, we assess key performance indicators for residences that we operate in all reported periods, or “same residence” operations.  Same residence operations include those residences that have been available for occupancy for the entire reporting period.  For the three year reporting period below, residences which are not considered same residence include six residences consisting of 250 units which were closed at any point in time since January 1, 2010 and three additions consisting of 68 units which were added to existing properties and were opened during the three year reporting period. The number of units, occupancy or payer mix associated with these residences were not materially different from data included in all residences; therefore, same residence information has been omitted from our discussion of key performance indicators.
 
 
All Residences

The following table sets forth our average daily census for the years ended December 31, 2012, 2011 and 2010 for both private pay and Medicaid residents for all residences whose results are reflected in our consolidated financial statements:

Average Daily Census
   
2012
   
2011
   
2010
 
Private pay
    5,364       5,542       5,483  
Medicaid
    5       70       151  
Total ADC
    5,369       5,612       5,634  
Private pay occupancy mix
    99.9 %     98.8 %     97.3 %
Private pay revenue mix
    99.9 %     99.3 %     98.3 %

During 2012, total ADC decreased 4.3% from the prior year. Private pay ADC decreased 3.2% from the prior year primarily due to the ending of certain rate concessions offered in 2011 and an increase in market rates we charge as of January 1, 2012. The remaining reduction was due to the planned reduction of residents paying through Medicaid. During 2011, total ADC decreased 0.4% from the prior year.  Private pay ADC increased 1.1% from the prior year primarily due to increases in occupancy in the new additions and existing units, partially offset by the Economic Impact.  As a result of the increase in private pay residents, the private pay occupancy mix increased in percentage from 97.3% to 98.8% and the private pay revenue mix increased from 98.3% to 99.3%.

Occupancy Percentage

Occupancy percentages are affected by the completion and opening of new residences and additions to existing residences as well as the temporary closure of residences for refurbishment. As total capacity increases from the addition of expansion units or a new residence, occupancy percentages are negatively impacted as the residence is filling the additional units.  After the completion of construction, we generally plan for additional units to take anywhere from one to one and a half years to reach optimum occupancy levels.  The temporary closure of residences for refurbishment generally has a positive impact on occupancy percentages.

 
Because of the impact that developmental units have on occupancy rates, when material, we split occupancy information between mature and developmental units.  In general, developmental units are defined as the additional units in a residence that has undergone an expansion or in a new residence that has opened.  New units identified as developmental are classified as such for a period of no longer than twelve months after completion of construction. The number of units, occupancy or payer mix associated with the residences considered to be developmental and not mature are immaterial; therefore, mature versus development information has been omitted from our discussion of key performance indicators.

All Residences

The following table sets forth our occupancy percentages for the years ended December 31, 2012, 2011 and 2010 for all residences whose results are reflected in our consolidated financial statements.
Occupancy Percentage
   
2012
   
2011
   
2010
 
Total residences
    60.5 %     62.4 %     62.5 %

For 2012, occupancy percentage decreased from 62.4% to 60.5%. The decrease in occupancy is primarily due to the ending of certain rate concessions offered in 2011 and an increase in market rates we charge as of January 1, 2012. The remaining reduction was due to the planned reduction of residents paying through Medicaid. For 2011, occupancy percentage was essentially unchanged.  Medicaid occupancy continued to decline and was partially offset by an increase in private pay occupancy.  
 
 
33

 
Average Revenue Rate

All residences

The following table sets forth our average daily revenue rates for the years ended December 31, 2012, 2011 and 2010 for all residences whose results are reflected in our historical consolidated financial statements:

   
2012
   
2011
   
2010
 
Average daily revenue rate
  $ 116.22     $ 114.46     $ 113.37  

The average daily revenue rate increased 1.5% and 1.0% in 2012 and 2011, respectively.  In 2012, the average daily revenue rate increased primarily due to annual rate increases for private pay residents. In 2011, the average daily revenue rate increased primarily as a result of annual rate increases for private pay residents and to a lesser extent than prior years, an improvement in the private pay revenue mix.  Rate increases were, however, offset by more aggressive room and board promotional discounts beginning in the third quarter of 2011.

Number of Residences Under Operations

The following table sets forth the number of residences under operations as of December 31:
 
   
2012
   
2011
   
2010
 
Owned(1)
    173       161       161  
Under operating leases
    38       50       50  
Total under operation
    211       211       211  
                         
Percent of residences:
                       
Owned
    82.0 %     76.3 %     76.3 %
Under operating leases
    18.0       23.7       23.7  
      100.0 %     100.0 %     100.0 %
(1)  Includes 11, eight and six temporarily closed residences in 2012, 2011 and 2010, respectively.

 
34


ADJUSTED EBITDA and ADJUSTED EBITDAR

The following table sets forth a reconciliation of net income to Adjusted EBITDA and Adjusted EBITDAR for the years ended December 31:
 
   
2012
     
2011
     
2010
 
           
(In thousands)
         
Net (loss)/income
$
(26,125
)
 
$
24,360
   
$
16,484
 
Income tax (benefit)/expense
 
(17,418
)
   
12,100
     
9,449
 
Income from operations before income taxes
 
(43,543
)
   
36,460
     
25,933
 
Add:
                     
Depreciation and amortization
 
24,915
     
23,103
     
22,806
 
Write off of operating lease intangible, lease termination fee and litigation settlement
 
46,080
     
     
 
Write-down of equity investments
 
     
     
2,026
 
Gain on sale of securities
 
 (257
)
   
 (956
)
   
 (23
)
Interest income
 
 (9
)
   
 (12
)
   
 (11
)
Interest expense
 
8,143
     
8,040
     
7,782
 
Loss on impairment of long-lived assets
 
3,500
     
     
 
Non-cash equity  based compensation
 
779
     
1,199
     
659
 
Transaction fees
 
1,046
     
     
128
 
Loss (gain) on sale or disposal of fixed assets
 
249
     
(121
)
   
224
 
Write-off of deferred financing fees
 
1,137
     
279
     
 
Recovery of debt-related purchase accounting reserve
 
     
(168
)
   
 
Adjusted EBITDA  
42,040
     
67,824
     
59,524
 
Add: Lease expense  
13,369
     
17,686
     
19,846
 
Adjusted EBITDAR $
 55,409
    $
 85,510
    $
 79,370
 
 
The following table sets forth the calculations of Adjusted EBITDA and Adjusted EBITDAR percentages for the years ended December 31 (dollars in thousands):

   
2012
     
2011
     
2010
 
Revenues
$
 228,397
   
$
 234,452
   
$
 233,128
 
Adjusted EBITDA
$
 42,040
   
$
 67,824
   
$
 59,524
 
Adjusted EBITDAR
$
 55,409
   
$
 85,510
   
$
 79,370
 
Adjusted EBITDA as percent of total revenue
 
18.4
%
   
28.9
%
   
25.5
%
Adjusted EBITDAR as percent of total revenue
 
24.3
%
   
36.5
%
   
34.0
%

For 2012, Adjusted EBITDA decreased by $25.8 million, or 38.0%, from 2011 and Adjusted EBITDAR decreased by $30.1 million, or 35.2%, from 2011.

For 2011, Adjusted EBITDA increased by $8.3 million, or 13.9%, over 2010 and Adjusted EBITDAR increased by $6.1 million, or 7.7%, over 2010.

Both Adjusted EBITDA and Adjusted EBITDAR decreased in the year ended December 31, 2012 primarily from an increase in residence operations expenses ($17.2 million) (this excludes the gain on disposal of fixed assets and the write-off of construction costs), a decrease in revenues discussed below ($6.1 million) and an  increase in general and administrative expenses ($6.8 million) (this excludes non-cash equity based compensation) and, for Adjusted EBITDA only, a decrease in residence lease expense ($4.3 million).

Both Adjusted EBITDA and Adjusted EBITDAR increased in the year ended December 31, 2011 primarily from a decrease in residence operations expenses ($2.7 million) (this excludes the gain on disposal of fixed assets), a decrease in general and administrative expenses ($2.1 million) (this excludes non-cash equity based compensation), the increase in revenues discussed below ($1.3 million) and, for Adjusted EBITDA only, a decrease in residence lease expense ($2.2 million).

Please see the review of consolidated results of operations below for a discussion of the fluctuations in the components of Adjusted EBITDA and Adjusted EBITDAR.

Please see “— Business Overview — Key Performance Indicators — Adjusted EBITDA and Adjusted EBITDAR” above for a discussion of our use of Adjusted EBITDA and Adjusted EBITDAR and a description of the limitations of such use.
 
 
35


Consolidated Results of Operations

Three Year Financial Comparative Analysis

The following table sets forth details of our revenues and income as a percentage of total revenues for the years ended December 31:
 
   
2012
   
2011
   
2010
 
Revenues
    100.0 %     100.0 %     100.0 %
Residence operations (exclusive of depreciation and amortization and residence lease expense shown below)
    67.4       58.3       59.9  
General and administrative
    8.7       5.7       6.5  
Residence lease expense
    5.9       7.5       8.5  
Lease termination and settlement
    16.4              
Depreciation and amortization
    10.9       9.9       9.8  
Impairment of intangibles
    3.8              
Impairment of long-lived asset
    1.5              
Transaction costs
    0.5              
Total operating expenses
    115.1       81.4       84.7  
(Loss)/income from operations
    (15.1 )     18.6       15.3  
Other-than-temporary investment impairments
                (0.9 )
Gain on sale of securities
    0.1       0.4        
Interest income
                 
Interest expense
    (4.1 )     (3.4 )     (3.3 )
(Loss)/income from operations before income     taxes
    (19.1 )     15.6       11.1  
Income tax benefit/(expense)
    7.7       (5.2 )     (4.0 )
Net (loss)/income
    (11.4 %)     10.4 %     7.1 %

Year Ended December 31, 2012 Compared with the Year Ended December 31, 2011

Revenues

Revenues in the year ended December 31, 2012 decreased by $6.1 million from the year ended December 31, 2011 primarily due to a decrease in private pay occupancy ($7.5 million), and the planned reduction in the number of units occupied by Medicaid residents ($1.6 million), partially offset by higher average daily revenue from rate increases ($2.4 million) and one additional day in the 2012 period due to leap year ($0.6 million).  Average rates increased in the year ended December 31, 2012 by 1.5% over average rates for the year ended December 31, 2011.

Residence Operations (exclusive of depreciation and amortization and residence lease expense shown below)

Residence operations expense increased $17.5 million, or 12.8%, to $154.2 million in the year ended December 31, 2012 compared to the year ended December 31, 2011. Residence operations expenses increased $11.0 million for new employees related to our improved quality and clinical initiatives, $1.7 million associated with higher professional fees associated with regulatory issues, $1.3 million for increased building maintenance, $1.1 million from higher insurance expense, $1.0 million for increased kitchen and food expenses related to our improved quality and clinical initiative, a $0.5 million increase in bad debt expense, a $0.5 million increase in property taxes, and a $0.4 million increase from the write off of projects which management determined would not be completed.

General and Administrative

General and administrative costs increased $6.5 million, or 48.4% to $19.8 million in the year ended December 31, 2012. General and administrative expenses increased $4.8 million for legal fees associated with the internal Board of Directors’ investigation and the Securities and Exchange Commission investigation, $1.6 million in compensation expense for new employees related to our improved quality and clinical initiatives, $0.5 million for consulting fees related to our public relations and quality initiatives, $0.3 million for legal fees associated with litigation and lease termination matters with Ventas Realty, $0.3 million for increased Board of Director fees associated with new Board level committees and an increase in the number of meetings held, $0.3 million for increased travel expenses, and $0.3 million for other administrative expenses, partially offset by a $1.6 million decrease in bonus and stock option compensation reductions as a result of the forfeiture of employee stock options by the terminated Chief Executive Officer.
 
 
36


Residence Lease Expense

Residence lease expense for the year ended December 31, 2012 decreased $4.3 million, or 24.4%, to $13.4 million from the year ended December 31, 2011.  Residence lease expense decreased primarily due to the purchase of 12 previously leased properties on June 15, 2012.

Lease Termination and Settlement

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 and settle a lawsuit brought by Ventas Realty against ALC with respect to the Master Leases, the Properties and the Guaranty of Lease for a purchase price of $100 million. The fair market value of the assets received as determined by third party appraisals was $62.5 million.  The net difference of $37.5 million represents the lease termination fee and cost to settle the lawsuit.

Depreciation and Amortization

Depreciation and amortization increased $1.8 million to $24.9 million in the year ended December 31, 2012 compared to the year ended December 31, 2011.  Depreciation increased $1.3 million primarily due to the purchase of the 12 previously leased residences on June 15, 2012.  Amortization expense decreased $0.3 million primarily because in place leases were fully amortized in 2011 and $0.2 million because of an operating lease intangible that was written off in the second quarter of 2012 in conjunction with the purchase of the 12 previously leased properties.

Impairment of Intangibles

We incurred an impairment expense on a lease intangible asset of $8.7 million related to the purchase of 12 previously leased properties from Ventas Realty and MLD, as the corresponding lease intangible asset was written off.

 Impairment of Fixed Assets

During the year ended December 31, 2012, we recognized $3.5 million of impairment charges primarily as a result of writing down the carrying value of assets to their estimated fair value as determined by independent third party appraisals. The gross carrying cost of land was written down by $0.2 million and the gross carrying cost of buildings was written down by $3.3 million.

Transaction Costs

We incurred transaction costs of $1.0 million from the purchase of the 12 previously leased properties from Ventas Realty and MLD.
 
Loss/Income from Operations

Loss from operations for the year ended December 31, 2012 was $34.5 million compared to income from operations of $43.6 million for the year ended December 31, 2011 due to the reasons described above.

Interest Income

Interest income was not significantly different in the year ended December 31, 2012 compared to the year ended December 31, 2011.

Interest Expense

Interest expense increased $1.1 million to $9.2 million in the year ended December 31, 2012, compared to the year ended December 31, 2011.  Interest expense increased $1.5 million on the U. S. Bank Credit Facility, and $1.1 million for the accelerated amortization of financing fees associated with the U.S. Bank Credit Facility borrowing capacity reduction, partially offset by a $1.0 million decrease from losses on interest rates swaps in 2011 that did not occur in 2012, a $0.3 million decrease in mortgage interest and a reduction of amortization of other financing fees of $0.2 million.
 
 
37

 
Gain on Sale of Securities
 
ALC recorded a $0.3 million gain associated with the sale of equity investments in the year ended December 31, 2012.  The  gain on the sale of securities in the year ended December 31, 2011 was $1.0 million.

Loss/Income before Income Taxes

Loss before income taxes for the year ended December 31, 2012 was $43.5 million compared to income before income taxes of $36.5 million for the year ended December 31, 2011 due to the reasons described above.

Income Tax Benefit/Expense

Income tax benefit for the year ended December 31, 2012, was $17.4 million compared to income tax expense of $12.1 million for the year ended December 31, 2011.  Our effective tax benefit rate was 40.0% compared to our effective tax expense rate of 33.2% for the year ended December 31, 2012, and 2011, respectively. Our effective income tax expense rate was favorably impacted in 2011 by a settlement with Extendicare, Inc. regarding a dispute associated with a tax allocation agreement entered into in connection with our separation from Extendicare in 2006.  Our effective income tax rate excluding this settlement would have been 37.0%.  Our income tax benefit rate in the year ended December 31, 2012 increased due to the size of our pre-tax loss relative to our permanent differences.

Net Loss/Income

Net loss for the year ended December 31, 2012, was $26.1 million compared to net income of $24.4 million for the year ended December 31, 2011, due to the reasons described above.
Year Ended December 31, 2011 Compared with the Year Ended December 31, 2010

Revenues

Revenues in the year ended December 31, 2011 increased from the year ended December 31, 2010 primarily due to higher average daily revenue from rate increases ($1.0 million) and an increase in private pay occupancy ($2.5 million), partially offset by the planned reduction in the number of units occupied by Medicaid residents ($2.2 million).  Average private pay rates increased in the year ended December 31, 2011 by 0.5% over average private pay rates for the year ended December 31, 2010.  Average overall rates, including the impact of improved payer mix, increased in the year ended December 31, 2011 by 1.0% over the comparable rates for the year ended December 31, 2010.

Residence Operations (exclusive of depreciation and amortization and residence lease expense shown below)

Residence operating costs decreased $3.0 million, or 2.2%, in the year ended December 31, 2011 compared to the year ended December 31, 2010.  Residence operations decreased $2.4 million from lower salaries and benefits, $0.3 million from lower kitchen expenses and $0.2 million from lower general and professional liability costs.  In addition, general economic conditions enabled us to hire new employees at lower wage rates. Kitchen expenses were lower due to new group purchasing plans and lower overall occupancy.

General and Administrative

General and administrative costs decreased $1.7 million, or 11.4%, in the year ended December 31, 2011 compared  to December 31, 2010.  General and administrative expenses decreased $0.5 million from non-recurring expenses associated with the realignment of our divisions in the 2010 period,  $0.6 million from the reversal of a purchase accounting adjustment and $0.5 million from lower travel costs.

Residence Lease Expense

Residence lease expense for the year ended December 31, 2011 decreased $2.2 million, or 10.9%, from the year ended December 31, 2010.  The acquisition of nine formerly leased properties on November 1, 2010 reduced lease expense by $2.0 million and resulted in the reversal of a purchase accounting reserve of $0.2 million.
 

Depreciation and Amortization
 
Depreciation and amortization increased $0.3 million to $23.1 million in the year ended December 31, 2011 compared to the year ended December 31, 2010.  Depreciation expense increased $0.8 million in the year ended December 31, 2011 as a result of the incremental depreciation on an addition opening in July of 2010, an addition opening in February of 2011, and from general capital expenditures across our portfolio. Amortization expense for the year ended December 31, 2011 decreased $0.5 million from the year ended December 31, 2010 because a component of our intangible assets became fully amortized in January of 2011.

Income from Operations

Income from operations for the year ended December 31, 2011 was $43.6 million compared to income from operations of $35.7 million for the year ended December 31, 2010 due to the reasons described above.

Other-Than-Temporary Investments Impairment

There was no other than temporary investment impairments in the year ended December 31, 2011.  Other-than-temporary investments impairment was $2.0 million in the year ended December 31, 2010. In the second quarter of 2010, we performed a quarterly review of investment securities and determined impairment of certain investments was other-than-temporary.

Gain on Sale of Securities

ALC recorded a $1.0 million gain associated with the sale of equity investments in the year ended December 31, 2011.  The  gain on the sale of securities in the year ended December 31, 2010 was $23,000.

Interest Income

Interest income was relatively unchanged in the year ended December 31, 2011 compared to the year ended December 31, 2010.

Interest Expense

Interest expense increased $0.4 million to $8.1 million in the year ended December 31, 2011, compared to the year ended December 31, 2010.  Interest on debt (including amortization on financing fees) increased by $0.6 million due to the full year impact of a $12.3 million mortgage financing completed at the end of the third quarter of 2010.  Interest expense also increased $0.3 million due to the write off of the remaining deferred financing costs associated with the revolving credit facility with General Electric Capital Corporation and other lenders (the “GE Credit Facility”). Recovery of a purchase accounting adjustment related to the early repayment of one of the HUD loans reduced interest expense by $0.2 million.  Interest expense on floating rate debt declined by $0.3 million due to a $22.1 million lower average outstanding balance in 2011 compared to 2010.
 
Income from Operations before Income Taxes

Income from operations before income taxes for the year ended December 31, 2011 was $36.5 million compared to income from operations before income taxes of $25.9 million for the year ended December 31, 2010 due to the reasons described above.

Income Tax Expense

Income tax expense for the year ended December 31, 2011 was $12.1 million compared to $9.4 million for the year ended December 31, 2010.  Our effective income tax rates were 33.2% and 36.4% for the years ended December 31, 2011 and 2010, respectively. In 2011, our effective income tax rate was favorably impacted  by a settlement related to a tax allocation agreement (a 2.0% reduction in the 2011 effective income tax rate) entered into in connection with our separation from Extendicare in 2006 and the reversal of certain state tax reserves due to the expiration of the statute of limitations (a 1.6% reduction in 2011 effective income tax rate).  Our effective income tax rate excluding these items would have been 36.8%.  Excluding these items, effective income tax rates for the year ended December 31, 2011 increased from the year ended December 31, 2010 due to an increase in taxable income.
 
 
39

 
Net Income
 
Net income for the year ended December 31, 2011 was $24.4 million compared to net income of $16.5 million for the year ended December 31, 2010 due to the reasons described above.

Liquidity and Capital Resources

Three Year Financial Comparative Analysis

Sources and Uses of Cash

We had cash and cash equivalents of $10.2 million at December 31, 2012 compared to $2.7 million at December 31, 2011, and $13.4 million at December 31, 2010.  The table below sets forth a summary of the significant sources and uses of cash for the years ended December 31:

   
2012
   
2011
   
2010
 
   
(In thousands)
 
Cash (used in)/provided by operating activities
  $ (927 )   $ 54,675     $ 46,172  
Cash used in investing activities
    (78,970 )     (12,385 )     (44,422 )
Cash provided by/(used in) by financing activities
    87,427       (53,002 )     7,254  
Increase/(decrease) in cash and cash equivalents
  $ 7,530     $ (10,712 )   $ 9,004  

Cash (used in)/provided by operating activities

Cash flow used in operating activities was $0.9 million in 2012 compared to cash flow provided in operating activities of $54.7 million in 2011, and $46.2 million in 2010.

2012 vs. 2011 cash (used in) operating activities:

Decreased cash flow from operations in 2012 was primarily due to:

 
§
$54.8 million from an decrease in net income adjusted for non-cash charges;

 
§
$3.2 million from decreases in income taxes payable/receivable;
 
 
 
§
$3.0 million from increases in deferred revenue;

 
§
$1.5 million from decreases in changes in other non-current assets,

partially offset by:

 
§
$4.3 million from increases in accrued liabilities; and

 
§
$2.6 million  from decreases in accounts receivable.

2011 vs. 2010 cash provided by operating activities:

Increased cash flow from operations in 2011 was primarily due to:

 
§
$4.8 million from an increase in net income adjusted for non-cash charges;

 
§
$4.8 million from increases in deferred revenues;

 
§
$2.4 million from increases in accounts payable;
 
 
§
$1.0 million from decreases in other non-current assets;

 
§
$0.7 million from decreases in deposits in escrow; and

 
§
$0.1 million of other changes,
 
 
40

 
partially offset by:
 
 
§
$1.7 million from increases in accounts receivable;

 
§
$1.4 million from decreases in accrued liabilities;

 
§
$0.7 million from increases in prepaids, supplies and other receivables;

 
§
$0.6 million  from increases in income taxes receivable;

 
§
$0.5 million from decreases in other long-term liabilities; and

 
§
$0.5 million for increases in long-term discontinued assets.

Working capital

2012 vs. 2011 working capital changes:

In 2012 our working capital decreased by $106.9 million from 2011 while in 2011 our working capital decreased by $15.0 million from 2010.  The decrease in working capital in 2012 as compared to 2011 was primarily due to an increase in current maturities of long-term debt of $112.1 million, an increase in accrued liabilities of $3.2 million, an increase in accounts payable of $2.9 million, a decrease in investments of $0.9 million, an increase in deferred revenue of $0.3 million, a decrease in deposits in escrow of $0.3 million, and a decrease in accounts receivable of $0.2 million,  partially offset by an increase in cash and cash equivalents of $7.5 million,  an increase in income taxes receivable of $3.5 million,  an increase in prepaids, supplies and other assets of $1.5 million and an increase in deferred income taxes of $0.6 million.

It is not unusual for us to operate in the position of a working capital deficit because our revenues are collected more quickly, often in advance, than our obligations are required to be paid. This can result in a low level of current assets to the extent cash has been deployed in business development opportunities or used to pay off longer term liabilities.  Because our borrowings under the U.S. Bank Credit Facility are due within the current year pursuant to the Third Amendment, the $108.0 million outstanding under the U.S. Bank Credit Facility was classified as a current liability in our consolidated financial statements.

2011 vs. 2010 working capital changes:

In 2011 our working capital decreased by $15.0 million from 2010 while in 2010 our working capital increased by $12.4 million from 2009.  The decrease in working capital in 2011 as compared to 2010 was primarily due to a decrease in cash and cash equivalents of $10.7 million, an increase in deferred revenue of $3.2 million, a decrease in investments of $2.8 million, a decrease in deferred taxes of $1.1 million, an increase in accounts payable of $0.9 million, a decrease in deposits in escrow of $0.3 million, a decrease in non-current discontinued assets of $0.2 million and an increase in current maturities of long-term debt of $0.1 million,  partially offset by a decrease in accrued liabilities of $2.3 million,  an increase in accounts receivable of $1.4 million,  an increase in prepaids, supplies and other accounts receivable of $0.4 million and an increase in income taxes receivable of $0.3 million.

Cash used in investing activities

Cash used in investing activities was $79.0 million, $12.4 million, and $44.4 million for 2012, 2011 and 2010, respectively.

2012 vs. 2011 cash used investing activities:

The increase of $66.6  million in cash used for investing activities between 2012 and 2011 was due to:

 
§
$62.6 million from an increase in cash used for an acquisition;

 
§
$2.2 million from a decrease in cash provided by the sale equity securities;

 
§
$1.6 million from an increase in cash used for new construction projects; and

 
§
$1.5 million from an increase in cash used for purchasing property and equipment.
 
 
41

 
partially offset by:
 
 
§
$1.3 million from an increase in cash provided from the sale of fixed assets.

2011 vs. 2010 cash used investing activities:

The decrease of $32.0  million in cash used for investing activities between 2011 and 2010 was due to:

 
§
$27.5 million from a decrease in cash used for an acquisition;

 
§
$4.9 million from a decrease in cash used for new construction projects;

 
§
$3.5 million from an increase in cash provided by the purchase and sale of equity securities; and

 
§
$0.2 million from an increase in cash provided by the sale of fixed assets,

partially offset by:

 
§
$4.1 million from an increase in cash used for purchases of property and equipment.

2012 vs. 2011 property and equipment

Property and equipment  increased by $51.2 million in 2012.  Property and equipment increased by:

 
§
$62.6 million from the acquisition of twelve previously leased properties,
 
§
$13.5 million from other capital expenditures,
partially offset by:

 
§
$24.9 million from depreciation expense.

2011 vs. 2010 property and equipment

Property and equipment decreased by $6.6 million in 2011.  Property and equipment decreased by:

 
§
$21.9 million from depreciation expense,

partially offset by:

 
§
$14.6 million from capital expenditures (excluding new construction projects); and

 
§
$0.7 million from new construction projects.

Cash provided by/(used in)financing activities

Cash provided by/(used in) financing activities was $87.4 million, $(53.0) million and $7.3 million for 2012,  2011, and 2010,  respectively.

For 2012, cash provided by financing activities included:

 
§
$195.0 million of  borrowings on our revolving credit facility;

partially offset by:

 
§
$99.0 million to pay back borrowings on our revolving credit facility; and

 
§
$4.6 million to pay dividends.

 
§
$2.6 million of payment on mortgage debt, and

 
§
$1.4 million of payment for financing costs
 
 
42

 
For 2011, cash used by financing activities included:

 
§
$137.5 million to pay back borrowings on our revolving credit facility;

 
§
$6.9 million to pay dividends;

 
§
$0.8 million of repurchases of Class A Common Stock;

 
§
$5.7 million of scheduled principal payments; and

 
§
$1.9 million for refinancing costs,

partially offset by:

 
§
$99.5 million of borrowings on our revolving credit facility; and

 
§
$0.3 million provided by the issuance of Class A Common Stock from stock options.

2012 vs. 2011 Long-term debt

Total long-term debt, including current and long-term maturities, increased by $93.5 million during 2012 primarily from:

 
§
$62.6 million for the acquisition of properties,
 
§
$17.4 million for other capital expenditures,
 
§
$7.5  million from an increase in cash balances,
 
§
$4.6 million for the payment of dividends and;
 
§
$1.4 million in other transactions.
2011 vs. 2010 Long-term debt

Total long-term debt, including current and long-term maturities, decreased by $43.9 million during 2011 primarily from:

 
§
$54.7 million of cash from operating activities (excluding amortization of debt purchase accounting market value adjustment of $0.2 million);

 
§
$10.7 million from a decrease in cash balances; and

 
§
$2.2 million from other transactions,

partially offset by:

 
§
$0.8 million from repurchases of Class A Common Stock;

 
§
$6.9 million for the payment of dividends; and

 
§
$15.8 million of capital expenditures.
 
 
43

 
Debt Instruments
 
Summary of Long-Term Debt
 
December 31,
 
   
2012
     
2011
 
   
(In thousands)
$125 million credit facility bearing interest at floating rates, due February 2016(1)
$
108,000
   
$
12,000
 
$120 million credit facility bearing interest at floating rates
 
     
 
Mortgage note, bearing interest at 6.24%, due 2014
 
30,708
     
31,703
 
Mortgage note, bearing interest at 6.50%, due 2015
 
23,834
     
24,775
 
Mortgage note, bearing interest at 7.07%, due 2018
 
8,391
     
8,552
 
Oregon Trust Deed Notes, weighted average interest rate of 7.33%, maturing from 2021  through 2026
 
6,946
     
7,274
 
HUD Insured Mortgages, interest rates ranging from 5.66% to 5.85%, due 2032
 
3,836
     
3,937
 
HUD Insured Mortgage, bearing interest at 7.55%, due 2036
 
     
 
Total debt
 
181,715
     
88,241
 
Less current maturities
 
 (114,575
)
   
 (2,538
)
Total long-term debt
$
67,140
   
$
85,703
 
(1) Prior to December 31, 2012, borrowings under this facility bore  interest at a floating rate at ALC’s option equal to LIBOR or prime plus a margin.  The margin was determined by ALC’s consolidated leverage ratio (as defined in the U.S. Bank Credit Facility) and ranged from 137.5 to 250 basis points over prime or 225 to 350 basis points over LIBOR.  From February 18, 2011 through May 6, 2011, ALC’s prime and LIBOR margins were 175 and 275 basis points, respectively.  On May 7, 2011, the prime and LIBOR margins were reduced to 150 and 250 basis points, respectively.  On December 31, 2012, commencing with the Third Amendment, the facility bears interest at the base rate plus 350 basis points.  At December 31, 2012, prime was 3.25% and one month LIBOR was 0.21%.  Pursuant to the Third Amendment, the debt associated with the U.S. Bank Credit Facility now expires in the current year.

$125 Million Credit Facility

On February 18, 2011, ALC entered into the U.S. Bank Credit Facility.  ALC’s obligations under the U.S. Bank Credit Facility are guaranteed by three ALC subsidiaries that own 36 residences with a combined net book value of $93.1 million and are secured by mortgage liens against such residences and by a lien against substantially all of the assets of ALC and those subsidiaries.  Prior to December 31, 2012, interest rates applicable to funds borrowed under the facility were based, at ALC’s option, on either a base rate essentially equal to the prime rate plus a margin or LIBOR plus a margin that varies according to a pricing grid based on a consolidated leverage test.  The First Amendment  (as defined below) increased the margins on base rate and LIBOR loans to 2.00% and 3.00%, respectively, and increased the quarterly commitment fee of .375% per annum on the unused portion of the facility to 0.5%.

On May 18, 2012, in anticipation of the purchase agreement with Ventas Realty, ALC entered into the first amendment to the U.S. Bank Credit Facility (the “First Amendment”). The First Amendment allowed ALC to exceed the limitation of $35,000,000 of consolidated growth capital expenditure per year. The First Amendment also limits ALC consolidated growth capital expenditures to $15,000,000 for the period from May 18, 2012 through December 31, 2012.  The annual limitation is restored to $35,000,000 for the year ended December 31, 2013 and each year thereafter.  ALC paid a fee of $0.4 million for the First Amendment which is being amortized over the remaining term of the U.S. Bank Credit Facility.

On August 1, 2012, ALC entered into waiver and amendment No. 2 to the U.S. Bank Credit Facility which provided for the definition of Consolidated EBITDA (as defined in the U.S. Bank Credit Facility) to be amended to (i) allow a one-time cash charge for a lease termination and settlement fee to net income to arrive at Consolidated EBITDA, (ii) require ALC to remove from the collateral pool any residence with an occupancy percentage of less than 62% for two consecutive months and replace it with a residence with an occupancy greater than 62% and (iii) limit the borrowing base to 70% of the aggregate value of the eligible collateral pool.  As of a result of this amendment, ALC added five properties comprising of 195 units to the collateral pool.

On December 31, 2012, ALC entered into the Third Amendment with the lenders currently party to the U.S. Bank Credit Facility.  For a description of the Third Amendment, see “—Credit Agreement Amendment” above.

In general, borrowings under the facility are limited to three and three quarters times ALC’s consolidated net income during the prior four fiscal quarters plus, in each case to the extent included in the calculation of consolidated net income, customary add-backs in respect of provisions for taxes, consolidated interest expense, amortization and depreciation, losses from extraordinary items, loss on the sale of property outside the ordinary course of business, and other non-cash expenditures (including the amount of any compensation deduction as the result of any grant of stock or stock equivalent to employees, officers, directors or consultants), non-recurring expenses incurred by ALC in connection with transaction fees and expenses for acquisitions minus, in each case to the extent included in the calculation of consolidated net income, customary deductions related to credits for taxes, interest income, gains from extraordinary items, gains from the sale of property outside the ordinary course of business and other non-recurring gains.
 
 
44


ALC is subject to certain restrictions and financial covenants under the facility including maintenance of greater than a minimum consolidated fixed charge coverage ratio, and restrictions on payments for capital expenditures, expansions and acquisitions. ALC may not make payments for dividends and stock repurchases.  In addition, upon the occurrence of certain transactions, including but not limited to property loss events, ALC may be required to make mandatory prepayments. ALC is also subject to other customary covenants and conditions.

Outstanding borrowings under the facility at December 31, 2012, and 2011were $108.0 million and $12.0 million, respectively.  In addition, the facility provided collateral for $5.0 million and $5.6 million in outstanding letters of credit at December 31, 2012 and 2011, respectively.  At December 31,  2012 and 2011, ALC was in compliance with all applicable covenants and available borrowings under the facility were $8.0 million and $107.4 million, respectively.

As described in more detail in “—Credit Agreement Amendment” above, we may not have been in compliance with certain covenants under our U.S. Bank Credit Facility as of December 31, 2012 if we had not entered into 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 under the U.S. Bank Credit Facility are due within the current year pursuant to the Third Amendment, the $108.0 million outstanding under the U.S. Bank Credit Facility was classified as a current liability in our consolidated financial statements.

 Mortgage  Note due 2014

The mortgage note due in 2014 (the “6.24% 2014 Note”) has a fixed interest rate of 6.24% with a 25-year principal amortization and is secured by 24 assisted living residences with a carrying value of $55.1 million.  Monthly principal and interest payments amount to approximately $0.3 million. A balloon payment of $29.6 million is due in January 2014.  The 6.24% 2014 Note was entered into by subsidiaries of ALC and is subject to a limited guaranty by ALC.

The 6.24% 2014 Note contains customary affirmative and negative covenants applicable to the ALC subsidiaries that are the borrowers under the property level financings, including:

 
§
Limitations on the use of rents;

 
§