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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                ----------------

                                    FORM 10-K

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                         COMMISSION FILE NUMBER: 0-26980

                                ----------------

                            ARV ASSISTED LIVING, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

             DELAWARE                                    33-0160968
 (STATE OR OTHER JURISDICTION OF          (I.R.S. EMPLOYER IDENTIFICATION NO.)
 INCORPORATION OR ORGANIZATION)

 245 FISCHER AVENUE, SUITE D-1,                              92626
   COSTA MESA, CALIFORNIA                                 (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                ----------------

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 751-7400

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


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       TITLE OF CLASS               NAME OF EACH EXCHANGE ON WHICH REGISTERED
       --------------               -----------------------------------------
<S>                                          <C>
 COMMON STOCK, NO PAR VALUE                  AMERICAN STOCK EXCHANGE
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                                ----------------

        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 [X] No [ ]

        Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [X] No [ ]

        As of MARCH 20, 2000, the aggregate market value of the voting stock
held by non-affiliates of registrant was $14,796,930 (for purposes of
calculating the preceding amount only, all directors, executive officers and
stockholders holding 5% or greater of the registrant's Common Stock are assumed
to be affiliates). The number of shares of Common Stock of the registrant
outstanding as of MARCH 20, 2000 WAS 17,459,689.


                      DOCUMENTS INCORPORATED BY REFERENCE:


        PORTION OF REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR ITS 2000 ANNUAL
MEETING OF STOCKHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III OF THIS
REPORT.


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                            ARV ASSISTED LIVING, INC.

                       INDEX TO ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999



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                                     PART I

Item 1:         Business............................................................................................     1
Item 2:         Properties..........................................................................................    18
Item 3:         Legal Proceedings...................................................................................    20
Item 4:         Submission of Matters to a Vote of Security Holders.................................................    21

                                     PART II

Item 5:         Market for the Registrant's Common Equity and Related Stockholder Matters...........................    22
Item 6:         Selected Financial Data.............................................................................    24
Item 7:         Management's Discussion and Analysis of Financial Condition and Results of Operations...............    25
Item 7a:        Quantitative and Qualitative Disclosures About Market Risk..........................................    35
Item 8:         Financial Statements and Supplementary Data.........................................................    35
Item 9:         Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................    35

                                    PART III

Item 10:        Directors and Executive Officers of the Registrant..................................................    35
Item 11:        Executive Compensation..............................................................................    35
Item 12:        Security Ownership of Certain Beneficial Owners and Management......................................    35
Item 13:        Certain Relationships and Related Transactions......................................................    35

                                     PART IV

Item 14         Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................    36
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                                     PART I



ITEM 1. BUSINESS

GENERAL

        ARV Assisted Living, Inc. ("ARV" or the "Company") is one of the largest
operators of licensed assisted living communities ("ALCs") in the United States.
We are a fully integrated provider of assisted living accommodations and
services that operates, acquires and develops ALCs. We have been continuously
involved in the senior housing business for more than 20 years. Our operating
objective is to provide high quality, personalized assisted living services to
senior residents in a cost-effective manner, while maintaining residents'
independence, dignity and quality of life. ALCs offer a combination of housing,
personalized support services and health care in a non-institutional setting.
They are designed to respond to the individual needs of elderly residents who
require assistance with certain activities of daily living, but who do not
require the intensive nursing care provided in a skilled nursing facility.

        In 1999 we embarked on a strategy to focus our efforts in the western
United States. To this end we have divested ourselves of many properties and
have put many more non-core properties up for sale. Previously we had planned to
expand our operations through the acquisition and development of new ALCs. In
1997 and 1998 expanded our operations through acquisitions in California, Ohio,
Florida, Indiana, Michigan, Arizona and Virginia, and have developed or are in
the process of constructing new ALCs in California, Nevada, Colorado, and Rhode
Island. At December 31, 1999, we operated 58 ALCs containing 7,192 units. Of the
58 ALCs, we owned 15, leased 36, and managed 7. On December 31, 1999 our
management contract with Altenheim for a 136 unit ALC ended and was not renewed.
Subsequent to December 31, 1999, we mutually agreed to terminate their
management agreement with Sterling Court for a 149 unit ALC effective March 1,
2000. We currently have 3 ALCs under construction and development that are
expected to contain approximately 403 units.

        Owned ALCs are owned by us directly, or by affiliated limited
partnerships or limited liability companies for which we serve as managing
general partner or member and community manager in which we have a majority
ownership interest ("Affiliated Partnerships"). Leased ALCs are operated under
long-term operating leases for our own account or for Affiliated Partnerships in
which we have a majority ownership interest. Managed ALCs are operated by us on
behalf of an affiliated partnership (in which we do not have a majority
ownership), joint ventures or an unrelated third-party. This blend of ownership
and management contracts allowed us to fund our operations in a balanced,
efficient manner.

         We have used lease and mortgage financing with health care real estate
investment trusts ("REITs"), private companies, commercial banks and a
convertible subordinated debt issuance to finance our capital expenditures and
operations. We plan to divest ALCs that do not meet our financial objectives or
geographic clustering strategy. Our primary geographic focus is the western
United States. In December 1999, we received letters of intent from potential
buyers to purchase twelve leased ALCs located outside of California.

        We intend to continue our focus on "private-pay" residents, who pay for
our services from their own funds or through private insurance. Currently,
approximately 96% of our residents are private-pay, while the remaining 4% of
the residents participate in the Supplemental Security Income ("SSI") program.
Certain states have enacted legislation enabling ALCs to receive Medicaid
funding similar to funding generally provided to skilled nursing facilities.
However, we do not try to attract residents with Medicaid funding since it is
insufficient to cover the cost of our accommodations and services.

        Our ALCs provide residents with accommodations, basic care services and
assisted living services. Our residents average 85 years of age and often
require assistance with certain activities of daily living. We provide our
residents with private or semi-private rooms or suites, meals in a
restaurant-style setting, housekeeping, linen and laundry services, activities
programs, utilities, and transportation in a van or minibus. For an additional
cost, we also provide assisted living services to residents who require help
with other activities of daily living, such as bathing, grooming, dressing,
personal hygiene, medication management and escort services to meals and
activities.

        Each ALC offers a Wellness Program that arranges for professional care
providers to deliver certain health care services to our residents that our ALCs
are not licensed or equipped to provide.



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        Partnerships affiliated with us have acquired or developed market rate
senior apartments as well as affordable senior and multifamily apartment
communities, using the sale of tax credits under a federal low income housing
tax credit program (the "Federal Tax Credit Program" or the "Apartment Group")
to generate the equity funding for development. In December 1997, as part of our
strategic plan, we determined that the Apartment Group was not part of our core
business, and adopted a plan for disposing of the business, which included 22
projects. To date, we have exited 13 partnerships, of the remaining 9, 2 we may
not be able to sell due to difficulty in obtaining partner's or lender's
approval and the remainder are still offered for sale.

THE ASSISTED LIVING MARKET

        Assisted Living. Assisted living is a stage in the elder care continuum,
midway between home-based care for independent and lower acuity residents and
the more acute level of care provided by skilled nursing facilities and acute
care hospitals. Assisted living represents a combination of housing,
personalized support services, and health care designed to respond to the
individual needs of the members of the senior population who need help in
activities of daily living, but do not need the medical care provided in a
skilled nursing facility.

        We believe our assisted living business benefits from significant trends
affecting the long-term care industry. The first is an increase in the demand
for elder care resulting from the continued aging of the U.S. population, with
the average age of our residents falling within the fastest growing segment of
the U.S. population. While increasing numbers of Americans are living longer and
healthier lives, many gradually require increasing assistance with activities of
daily living, and are not able to continue to age in place at home. The second
trend is the effort to contain health care costs by the government, private
insurers and managed care organizations by limiting lengths of stay, services,
and reimbursement to patients in acute care hospitals and skilled nursing
facilities. Assisted living offers a cost-effective, long-term care alternative
while preserving a more independent lifestyle for seniors who do not need the
broader array of medical services that acute care hospitals and skilled nursing
facilities are required to provide. As of December 31, 1999, monthly revenue
generated by our ALCs on a same community basis averaged $2,080 per occupied
unit, compared with $1,907 per occupied unit as of December 31, 1998. (We define
"same community" as those communities which we owned or leased for a period of
five quarters or more as of December 31, 1999.) Other trends include increases
in the financial net worth of the elderly population, the number of individuals
living alone, and the number of women who work outside the home who are less
able to care for their elderly relatives. We believe these trends will result in
a growing demand for assisted living services and communities.

        Aging Population. The primary consumers of long-term health care
services are persons over the age of 65. This group represents one of the
fastest growing segments of the population. According to U.S. Bureau of the
Census data, the segment of the population over 65 years of age is currently 13%
of the total population, or 34 million people. That number is projected to grow
to 20% of the total population, or 69 million people, by the year 2030.
Additionally, the number of people aged 85 and older, which comprises the
largest percentage of residents at long-term care facilities, is currently 3.7
million and is projected to increase to 8.5 million by the year 2030.

        Limitation on the Supply of Long-Term Care Facilities. The majority of
states in the U.S. have enacted Certificate of Need or similar legislation,
which generally limits the construction of skilled nursing facilities and the
addition of beds or services in existing skilled nursing facilities. High
construction costs, limitations on government reimbursement for the full cost of
construction, and start-up expenses also constrain growth in the supply of such
facilities. Such legislation benefits the assisted living industry by limiting
the supply of skilled nursing beds for the elderly. Cost factors are placing
pressure on skilled nursing facilities to shift their focus toward higher acuity
care, which enables them to charge more. This contributes to a shortage of lower
acuity care and thereby increases the pool of potential assisted living
residents.

        While Certificates of Need generally are not required for ALCs, except
in a few states, most states do require assisted living providers to license
their communities and comply with various regulations regarding building
requirements and operating procedures and regulations. States typically impose
additional requirements on ALCs over and above the standard congregate care
requirements. Further, the limited pool of experienced assisted living staff and
management, as well as the costs and start-up expenses to construct an ALC,
provide an additional barrier to entry into the assisted living business.

        Cost Containment Pressures of Health Reform. In response to rapidly
rising health care costs, both government and private pay sources have adopted
cost containment measures that encourage reduced lengths of stay in hospitals
and skilled nursing facilities. The federal government has acted to curtail
increases in health care costs under Medicare by limiting acute care hospital
and skilled nursing facility reimbursement to pre-established fixed amounts.
Private insurers have also begun to limit reimbursement for medical services in
general to predetermined "reasonable" charges. Managed care organizations, such
as health maintenance organizations



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("HMOs") and preferred provider organizations ("PPOs"), are reducing
hospitalization costs by negotiating discounted rates for hospital services and
by monitoring and decreasing hospitalization. We anticipate that both HMOs and
PPOs increasingly may direct patients away from higher cost nursing care
facilities into less expensive ALCs.

        These cost containment measures have produced a "push-down" effect. As
the number of patients being "pushed down" from acute care hospitals to skilled
nursing facilities increases, the demand for residential options such as ALCs to
serve patients who historically have been served by skilled nursing facilities
will also increase. In addition, skilled nursing facility operators are
continuing to focus on improving occupancy and expanding services (and fees) to
subacute patients requiring very high levels of nursing care. As the acuity
level of skilled nursing facility patients rises, the supply of nursing facility
beds will be filled by patients with higher acuity needs who pay higher fees.
This will provide opportunities for assisted living communities to increase
their occupancy and services to residents requiring lower levels of care than
patients in skilled nursing facilities generally receive.

OUR ASSISTED LIVING SERVICES

        We provide services and care which are designed to meet the individual
needs of our residents. The services provided are designed to enhance both the
physical and mental well-being of seniors in each of our ALCs by promoting their
independence and dignity in a home-like setting. Our assisted living program
includes the following:

        -       Personalized Care Plan. The focus of our strategy is to meet the
                specific needs of each resident. We customize our services
                beginning with the admissions process, at which time the ALC's
                management staff, the resident, the resident's family, and the
                resident's physician discuss the resident's needs and develop a
                "personalized" care plan. If recommended by the resident's
                physician, additional health care or medical services may be
                provided at the community by a third-party home health care
                agency or other medical provider. The care plan is reviewed and
                modified on a regular basis.

        -       Basic Service and Care Package. The basic service and care
                package at our ALCs generally include:

                --      meals in a restaurant-style, "home-like" setting;

                --      housekeeping;

                --      linen and laundry service;

                --      social and recreational programs;

                --      utilities; and

                --      transportation in a van or minibus.

        Other care services can be provided under the basic package based upon
the individual's personalized health care plan. Our policy is to charge base
rents that are competitive with similar ALCs in the local market. While the
amount of the fee for the basic service package varies from community to
community, on a same community basis the average basic monthly rental rate per
unit was approximately $1,733 per month as of December 31, 1999, compared with
an average of $1,541 as of December 31, 1998.

        -       Additional Services. Our assisted living services program offers
                levels of care in addition to the services offered in the basic
                package. The level of care a resident receives is determined
                through an assessment of a resident's physical and mental
                health. The assessment is conducted by the community's assisted
                living director, with input from other staff members. The
                six-tiered level of care rate structure is based on a point
                system. We assign points to the various care tasks required by
                the resident, based on the amount of staff time and expertise
                needed to accomplish the tasks. The point scale and pricing are
                part of the admissions agreement between the community, the
                resident and the resident's family. The community performs
                reassessments after the initial 30 days and periodically
                throughout the resident's stay to ensure that the level of care
                we provide corresponds to changes in a resident's condition. The
                types of services included in the assessment point calculation
                are:

                --      Medication management

                --      Assistance with dressing and grooming



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                --      Assistance with showering

                --      Assistance with continence

                --      Escort services

                --      Status checks related to a recent hospitalization,
                        illness, history of falls

                --      Help with psychosocial needs, such as memory deficit

                --      Special nutritional needs and assistance with eating

        In addition to the above services, we provide other levels of assistance
to residents at selected ALCs in order to meet individual needs, such as
assistance with diabetic care and monitoring, catheter, colostomy and ileosotomy
care, minor wound care needs and light to moderate transferring needs. Some of
our ALCs also operate memory loss units for residents with Alzheimer's disease
and related dementias. These units provide the attention and services required
by cognitively impaired residents to maintain a high quality of life in a secure
environment. Specially trained staffs provide personalized care, specialized
activity programs and oversee medication regimens.

        In addition to the base service package, we typically charge between
$375 and $1,375 per month or more for higher levels of assisted living services.
Fee levels vary from community to community and we may charge additional fees
for other specialized assisted living services. We expect that an increasing
number of residents will use additional levels of services as they age in our
ALCs. Our internal growth plan is focused on increasing revenue by continuing to
improve our ability to provide residents with these services.

        On a same community basis, the average monthly revenue per occupied unit
for both the basic service package and the assisted living services increased to
$2,059 from $1,793 for the year ended December 31, 1999 and the year ended
December 31, 1998, respectively. There can be no assurance that any ALC will be
substantially occupied at assumed rates at any time. In addition, we may only be
able to lease up our ALCs to full occupancy at rates below those assumed. If
operating expenses increase, local market conditions may limit the extent to
which we may increase rates. Because we must provide advance notice of rate
increases, generally at least 30 days, rate increases may lag behind increases
in operating expenses.

        Wellness Program. We have implemented a Wellness Program for residents
of our communities designed to identify and respond to changes in a resident's
health or condition. Together with the resident and the resident's family and
physician, as appropriate, we design a solution to fit that resident's
particular needs. We monitor the physical and mental well-being of our
residents, usually at meals and other activities, and informally as the staff
performs services around the facility. Through the Wellness Program we work
with:

        -       home health care agencies to provide services the community
                cannot provide;

        -       physical and occupational therapists to provide services to
                residents in need of such therapy; and

        -       long-term care pharmacies to facilitate cost-effective and
                reliable ordering and distribution of medications.

        We arrange for these services to be provided to residents as needed in
consultation with their physicians and families. At the present time, most of
our ALCs have a comprehensive Wellness Program.



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GROWTH STRATEGIES

        Overview. Our revised strategy to grow earnings and achieve
profitability is to increase our focus on operations and reduce the level of
development and acquisition activity we historically pursued. To strengthen the
operations of our ALCs, we will focus on improving margins by increasing
occupancy rates, raising or maintaining pricing structures to ensure that our
rates are competitive with comparable facilities in our local markets, and
expanding the level and depth of our assisted living services. Although our pace
of development is expected to slow, we will continue efforts to cluster our
portfolio of ALCs within certain geographic areas through the development,
acquisition or divestiture of selected assets. By concentrating on a clustering
strategy we expect to increase the efficiency of our management and marketing
resources and to achieve broader economies of scale.

        Our strategy is to target areas where there is a need for ALCs based on
demographics and market studies. In addition to developing ALCs through direct
ownership and the use of long-term leases, we may also divest ALCs that do not
expand or enhance one of our clusters or do not meet our financial objectives.
In December 1999, we received letters of intent to purchase twelve of the leased
ALCs located outside of the western United States. In March 2000 we entered into
a purchase and sale agreement for three of these properties. In 1998 we acquired
interests in 11 ALCs and one skilled nursing facility from Hillsdale Group, L.P.
(the "Hillsdale Transaction") and their affiliates, and opened five newly
constructed ALCs. The Hillsdale Transaction substantially increased our presence
in Northern and Southern California. During 1999 we completed the sale of five
ALCs that were outside of the western United States. Consequently, as of
December 31, 1999, a substantial portion of our business and operations were
conducted in California, where 39 of the 58 ALCs we operated are located.

        The market value of our properties and the income generated from ALCs we
own, manage or lease could be negatively affected by changes in local and
regional economic conditions and by acts of nature. A worsening of local
economic conditions could have a negative effect on our business.

        Development. Due to market conditions, the development of ALCs has been
curtailed during 1999. Although we did not abandon any of our current projects
we did not begin any new ones. Our primary development strategy is to work with
developers and builders in clustered geographic areas of the U.S. Typically,
regional developers receive development or construction fees in connection with
the construction of the project. In all cases, we have the right to approve
acquisitions and all aspects of development including site selection, design,
plans and specifications, development budgets, choice of general contractor and
major subcontractors, and other significant criteria.

        In developments financed through long-term operating leases, the
financier typically acquires the property when it is ready for construction. We
perform the development, either on our own or in conjunction with regional
developers, under a contractual arrangement with the owner. Concurrently, we
enter into a long-term operating lease that becomes effective when the ALC is
completed. The financier typically bears 100% of the budgeted development costs
which may also include our development or construction supervision fees. In most
instances where we provide development services, we bear the risk for cost
overruns. We typically incur up-front development costs in connection with the
due diligence and entitlement process, and architectural and engineering fees
when we are preparing the property for purchase by the financier at the
beginning of construction. Leases between us and a landlord entity are typically
interconnected. We are not entitled to exercise our right to renew one lease
with a particular lessor without exercising our right to renew all other leases;
and we will be required to maintain and rehabilitate all of the Leased ALCs with
any one landlord on a long-term basis.

        In 1998, we entered into joint ventures ("LLCs") designed to help us
finance development and renovation projects and to mitigate the impact of
start-up losses associated with the opening of newly constructed ALCs. The joint
ventures were formed to finance and manage the substantial renovation of
existing ALCs acquired in 1998 in the Hillsdale Transaction and to construct
three new communities on land sites we own. Participants in the joint ventures
with us include a third-party investor and a third-party developer. The LLCs
have contracted with the developer to provide development services to perform
the renovation and construction. We account for our investment in the joint
ventures using the equity method and losses incurred by the LLCs will be
allocated disproportionately to the joint venture partners based upon their
assumption of risk. We have an option to purchase the joint venturers' interest
in the LLCs when the ALCs reach stabilization, at a purchase price that is the
greater of fair market value or an amount that generates a guaranteed rate of
return on the joint venturers' capital contribution. There can be no assurance
that all of the construction and renovation projects contemplated under the
joint venture agreements will be completed, or that we will pursue similar joint
venture agreements in the future.

        We do not plan to continue to develop new ALCs for 2000, but currently
have 3 major development projects in progress which should all be completed in
2000. Our ability to achieve our development plans will depend upon a variety of
factors, many of which



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are beyond our control. These and other factors are detailed below. See "Risks
Common to Our Assisted Living Operations -- Development and Construction Risks."
Certain construction risks are beyond our control, including strikes, bad
weather, natural disasters, under supply of materials and labor, and other
unknown contingencies that could cause the cost and timing of construction to
exceed estimates. In order to keep our internal costs to a minimum, we rely on
third-party general contractors to construct new ALCs. Cash flow could be
reduced significantly if construction is not commenced or completed, or if there
are unpaid subcontractors or suppliers, or if required occupancy permits are not
issued in a timely manner. In addition, any property in construction is subject
to risks including construction defects, cost overruns, adverse weather
conditions, the discovery of geological or environmental hazards on the property
and changes in zoning restrictions or the method of applying such zoning
restrictions. The nature of licenses and approvals necessary for development and
construction, and the timing and likelihood for obtaining them, vary widely from
state to state, and from community to community within a state.

        Acquisitions. In evaluating possible acquisitions, we consider:

        -       the location, construction quality, condition and design of the
                ALC;

        -       the current and projected cash flow of the community and its
                anticipated ability to increase revenue through rent and
                occupancy increases, additional assisted living services and
                management; and

        -       whether we can acquire the community below replacement cost.

        Our sources for prospective acquisitions range from Affiliated
Partnerships to management's contacts with potential ALC sellers, to our local
and regional personnel who monitor the assisted living market in their area. In
certain cases we may also target additional third-party management contracts.
However, we do not intend to continue our past growth rate. Instead we will
focus greater attention and resources on enhancing the profitability of our
existing core operations and on leasing up new developments at a faster rate.

        Historically we have financed many of our acquisitions using equity and
debt and through direct long-term operating lease transactions with
institutional investors such as health care REITs, and may continue to do so in
the future. In long-term operating lease transactions, we typically arrange the
sale of the prospective assisted living community to a REIT or other
institutional investor while concurrently entering into a long-term operating
lease for the facility. Our initial cost is generally limited to a security
deposit that is typically provided through standby letters of credit.
Thereafter, we are obligated to make certain rental payments (which may include
an additional amount related to revenue of the community) for the term of the
lease. While we have financed a portion of our direct ownership of ALCs with
secured debt from REITs, we do not have any participation or sponsorship
interest in these entities. While we make our best estimates in projecting
lease-up costs and expenses as well as the achievement of rent stabilization,
our failure to generate sufficient revenue could result in an inability to meet
minimum rent obligations under our long-term operating leases.

        Increase in Sales of Additional Assisted Living Services. We believe
that many custodial services provided in skilled nursing facilities are
available in our ALCs at approximately two-thirds of the cost at skilled nursing
facilities. We believe that this differential will enable us to attract
additional residents. By increasing the use of these services by our residents,
we believe residents will be able to age in place at our ALCs over a longer
period of time, rather than having to transfer to more expensive skilled nursing
facilities until absolutely necessary.

        We seek to enhance and increase the amount and diversity of assisted
living services we provide through:

        -       the continued education of the senior community, and
                particularly the residents and their families, concerning the
                cost-effectiveness of receiving additional services in an
                assisted living community;

        -       the continued development and refinement of assisted living
                programs designed to meet the needs of our residents as they age
                in place; and

        -       the consistent delivery of quality services for residents.

EMPLOYEES

        At February 29, 2000 we had approximately 3,113 employees.



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CAPITAL REQUIREMENTS

        Our operating leases require security deposits. At December 31, 1999,
the amount of security deposits was $11.9 million either in cash or letter of
credit supported by cash.

        In June 1999, we refinanced 9 communities that are held by majority
owned partnerships to:

        -       take advantage of lower fixed interest rates available at the
                time through the commercial mortgage backed security market;

        -       provide a return of equity to the limited partners;

        -       borrow against the increased value of these properties; and

        -       finance the purchase of four ALCs that were previously operated
                under long term operating leases.

        As the general partner of the partnerships we distributed most of the
contributed capital from the refinancing to the limited partners and enhanced
our liquidity position in the partnerships. The term of the loans is two years
with a lender optional 10 year extension. The principal repayment is based upon
a 25 year amortization schedule with a fixed interest rate of 9.15%. A 2%
structuring fee was paid to the lender. In 1998, we paid a net $1.5 million rate
lock fee for a refinancing that did not consummate. This charge was taken in the
statements of operations presented for 1998. However, we feel we are entitled to
a full and complete return of the rate lock fees paid. We are pursuing a return
of all fees and are investigating our legal alternatives to that end; however,
there can be no assurances that additional interest rate lock fees will be
recovered.

        In our fiscal year ended December 31, 1999, we began retiring portions
of our 6 3/4% convertible subordinated debt from time to time. During that
fiscal year, we issued a total of 799,566 shares of our common stock and paid a
total of $1.0 million to some of our bondholders in exchange for a total of $9.2
million principal amount of the subordinated notes due 2006 that were held by
those bondholders. These transactions resulted in an extraordinary gain of $6.8
million net of tax as of our fiscal year ended December 31, 1999. During the
current fiscal year, we have issued a total of 781,025 share of our common stock
and paid a total of $0.9 million to additional bondholders in exchange for a
total of $7.8 million additional principal amount of the subordinated notes held
by those bondholders. These additional transactions resulted in an extraordinary
gain of $5.6 million net of tax as of March 21, 2000. Through these
transactions, we have retired a total of $17.1 million of our public debt
yielding extraordinary gains of $12.4 million to date.

        We will be required from time to time to incur additional indebtedness
or issue additional debt or equity securities to finance our business, including
the acquisition and development of ALCs as well as other capital expenditures
and additional funds to meet increased working capital requirements. We may
finance future acquisitions and development through a combination of our cash
reserves, assets sales, cash flow from operations, leasing of additional ALCs
and ALCs in development, sale/leaseback arrangements with respect to our owned
ALCs, and additional indebtedness or public or private sales of debt securities
or capital stock. We have arranged financing of our ALCs under construction and
development through commitments from various health care REITs and other
landlords and lenders. With respect to these ALCs, our commitments for capital
expenditures consist of potential liability for cost overruns incurred during
the construction of ALCs and our obligation to fund start-up losses incurred in
the operation of the ALCs prior to the achievement of stabilized operations.
While the amount of such obligations are contingent on our ability to develop
our ALCs within budget and achieve profitable operations, the probable amount of
these obligations cannot be definitively quantified. Nonetheless, we believe
that we have made adequate provision for such obligations in our financing plan.
There can be no assurance, however, that funds will be available on terms
favorable to us, that such funds will be available when needed, or that we will
have adequate cash available for such requirements.

FACTORS AFFECTING FUTURE RESULTS AND FORWARD-LOOKING STATEMENTS

Our business, results of operations and financial condition are subject to many
risks, including those set forth below. Certain statements contained in this
report, including without limitation statements containing the words "believes,"
"anticipates," "expects," and words of similar import, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company, or industry results, to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. We have made
forward-looking statements in this report concerning, among other things, the
impact of future acquisitions and developments, if any, and the level of future
capital expenditures. These statements are only predictions, however; actual
events or results may differ materially as a result of risks we face. These
risks include, but are not limited to, those items discussed below. Certain of
these factors are discussed in more detail elsewhere in this report, including
without limitation under the captions "Business" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations." Given these
uncertainties, we caution readers not to place undue reliance on such



                                       9
<PAGE>   10

forward-looking statements, which speak only as of the date of this report. We
disclaim any obligation to update any such factors or to publicly announce the
result of any revisions to any of the forward-looking statements contained here
to reflect future events or developments.

        We have experienced growth through the development and acquisition of
ALCs and by acquiring property for the development of new ALCs. Certain risks
are inherent with the execution of the development and acquisition of ALCs.
These risks include, but are not limited to:

        -       our ability to access capital necessary for operations,
                acquisition and development;

        -       our ability to sustain and manage growth and to successfully
                integrate new ALCs into our portfolio;

        -       governmental regulation;

        -       competition; and

        -       risks common to the assisted living industry.

HISTORY OF LOSSES

        For the year ended December 31, 1999 and December 31, 1998, and the
nine-month period ended December 31, 1997, we had net losses of approximately
$27.7 million, $46.0 million, and $22.1, respectively. At December 31, 1999, our
accumulated deficit was approximately $105.2 million.

        Our net loss for the year ended December 31, 1999 primarily resulted
        from:

        -       start-up losses on newly-developed ALCs;

        -       the impairment losses on ALCs held for sale;

        -       litigation judgement expenses and settlement of a lawsuit with
                Emeritus;

        -       legal expenses for and settlement of a lawsuit; and

        -       cumulative effect of change in accounting principle.

        Our net loss for the year ended December 31, 1998 primarily resulted
        from:

        -       start-up losses on newly-developed ALCs;

        -       the impairment losses on properties and ALCs held for sale;

        -       legal expenses on a lawsuit with LFREI and related parties;

        -       costs incurred in our proxy fight and litigation with Emeritus;

        -       interest rate lock fees paid in connection with the failed
                refinance of our majority-owned partnerships; and

        -       severance and other expenses related to changes in executive
                management and layoffs.

        Our loss for the nine months ended December 31, 1997, primarily resulted
        from:

        -       establishing a provision related to the disposition of our
                rehabilitation subsidiary, GeriCare, and the Apartment Group;

        -       costs incurred in our proxy fight with Emeritus;




                                       10
<PAGE>   11

        -       start-up losses on newly-developed ALCs;

        -       severance expenses related to the retirement of three senior
                executives; and

        -       the write-off of conversion costs after we determined that newly
                purchased accounting software contained numerous application
                errors.

See "Management's Discussion and Analysis of Financial Condition and Results of
Operations." We cannot provide assurance that the risks associated with an
opening newly-developed ALCs or assuming operations of acquired ALCs can be
managed to reduce or eliminate start-up losses, that other similar costs and
expenses or losses will not occur in the future. See "--Indebtedness, Lease and
Other Obligations," "-- General Partner Liability and Status," and "Management's
Discussion and Analysis of Financial Condition and Results of Operations".

RAPID GROWTH

        MANAGEMENT OF GROWTH. We have experienced rapid growth over the past
several years. To enable us to more effectively manage growth, we slowed the
pace of acquisitions and development in 1999. See "-- Risks Common to our
Assisted Living Operations." Our failure to effectively manage growth could have
a material adverse effect on operating results.

        EXTERNAL GROWTH. We may in the future enter into agreements to acquire
properties for development and for the acquisition of existing ALCs that are
subject to certain conditions. We cannot assure that one or more of such
acquisitions will be completed, that we will be able to find additional suitable
properties and ALCs, or that we can obtain financing to continue to acquire or
develop ALCs and property on which to build them. We expect to experience a
slowdown in growth through acquisition of ALCs due to shortages of suitable ALCs
available at attractive prices, due to limitations on obtaining financing, and
due to our intention to manage growth effectively as noted above. We also have
acquired a number of properties to be developed into ALCs, or have contracted to
lease or manage ALCs being developed by third-party developers. The development
of ALCs is subject to a number of risks, many of which are outside our control.
We cannot provide assurance that we will be able to complete our planned ALCs in
the manner, for the amount, or within the timeframe currently anticipated. Our
ability to generate revenue when anticipated could be affected by delays in the
progress or completion of development projects. See "-- Risks Common To Our
Assisted Living Operations -- Development and Construction Risks."

COMPETITION

        The health care industry is highly competitive and we expect that the
assisted living business, in particular, will become more competitive in the
future. Sources of competition include:

        -       family members providing care at home;

        -       numerous local, regional and national providers of assisted
                living and long-term care whose facilities and services range
                from home-based health care to skilled nursing facilities; and

        -       acute care hospitals.

        In addition, we believe that as assisted living receives increased
attention among the public and insurance companies, new competitors focused on
assisted living will enter the market, including hospitality companies expanding
into the market. Some of our competitors operate on a not-for-profit basis or as
charitable organizations, while others have, or are capable of obtaining,
greater financial resources than those available to us.

        We also expect to face increased competition for the acquisition and
development of ALCs. Some of our present and potential competitors are
significantly larger or have, or may obtain, greater financial resources than we
have. These forces could limit our ability to attract residents, attract
qualified personnel, expand our business, or increase the cost of future
acquisitions, each of which could have a material adverse effect on our
financial condition, results of operations and prospects.




                                       11
<PAGE>   12

INDEBTEDNESS, LEASE AND OTHER OBLIGATIONS

        We have financed, and may continue to finance, the acquisition and
development of ALCs through a combination of loans, leases and other
obligations. As of December 31, 1999, we had outstanding consolidated
indebtedness of $115.7 million, including $48.3 million of our 2006 Convertible
Notes, whose holders have the right to convert such notes into our common stock
at any time on or before the notes mature. In addition, at December 31, 1999, we
had $43.1 million in notes maturing within two years, none related to properties
held for sale. As a result, we will devote a portion of our cash flow to debt
service. There is a risk that we will not be able to refinance our maturing note
obligations on terms favorable to us, or that we will not be able to generate
sufficient cash flow from operations to make required interest and principal
payments.

        With respect to loans totaling $55.1 million we are the general partner
of certain limited partnerships that serve as the sole members of the three
borrowing entities formed as limited liability companies. Although, a member of
a limited liability company is not personally liable for any contract or other
obligation of that entity, we delivered limited guaranties in connection with
the loans. Due to the limited guaranties, we assumed no liability for repayment
of the loan indebtedness. However we are liable only as the result of fraudulent
or intentional misconduct regarding the mortgaged properties, an unconsented
transfer of a mortgaged property, a change of control by borrower, or violation
of hazardous materials covenants. In addition, we guaranteed the borrower's
obligation to rebalance the loans upon breach of debt service coverage
obligations.

        At December 31, 1999, approximately $25.6 million of our indebtedness
bore interest at floating rates. We may incur indebtedness in the future that
may also bear interest at a floating rate, or be fixed at some time in the
future. Therefore, increases in prevailing interest rates could increase our
interest payment obligations and could have an adverse effect on our business,
financial condition and operating results. In addition, we have guaranteed
mortgage and construction debt for the benefit of Tax Credit Affiliated
Partnerships of up to approximately $25.7 million, including $23.9 million
outstanding at December 31, 1999. As of February 29, 2000, we were able to
obtain permanent financing of $5.4 million on a Tax Credit Affiliated
Partnership and eliminate our guaranty of the loan indebtedness. Our guarantee
of this debt effectively subjects us to risks normally associated with leverage,
including:

        -       the risk that Affiliated Partnerships will not be able to
                refinance this debt with permanent financing;

        -       an increased risk of partnership cash flow deficits; and

        -       the risk that if the economic performance of any mortgaged asset
                declines, we will be obligated to make payments on the mortgage
                debt.

        These risks could adversely affect our operating results and financial
condition. Because certain of the indebtedness that we guarantee bears interest
at rates which fluctuate with certain prevailing interest rates, increases in
such rates could increase our interest payment obligations and could have an
adverse effect on our operating results and financial condition.

        With respect to other Tax Credit Affiliated Partnership loans totaling
$9.0 million we are the general partner of the borrower limited partnerships,
yet only have limited guaranty liability. Although a general partner is normally
liable for the obligations of the limited partnership, these particular loans do
not obligate us for repayment of the loan indebtedness. In this case, we are
liable only for fraud or intentional misconduct, damage or destruction of the
properties, environmental contamination, or interference with the lender's
collection of rents.

        In addition, as of December 31, 1999, we are a party to long-term
operating leases for certain of our Leased ALCs. These require minimum annual
lease payments aggregating $31.7 million for December 31, 2000 and $32.1 million
for December 31, 2001. These leases are non-cancelable, and typically have an
initial term of 10 to 15 years.

        We also have entered into guarantees (the "Tax Credit Guarantees") which
extend 15 years after project completion, relating to certain Apartment Group
assets financed under the Federal Tax Credit Program with respect to

        -       lien free construction;

        -       operating deficits; and

        -       obtaining and maintaining tax credit benefits to certain
                corporate investors (see "-- Tax Credit Apartment Properties"),
                the obligations under which, excluding potential penalties and
                interest factors, could amount to an approximate limit of $65.3
                million as of December 31, 1999. There can be no assurance that
                we will be able to negotiate a settlement of these liabilities
                during the disposition of the properties at terms favorable to
                us.



                                       12
<PAGE>   13

GENERAL PARTNER LIABILITY AND STATUS

        We, directly or through our subsidiaries, are a general partner in 13
partnerships as of December 31, 1999. As a general partner we are liable for
partnership obligations such as partnership indebtedness (which totaled
approximately $104.1 million at December 31, 1999), potential liability for
construction defects, including those presently unknown or unobserved, and
unknown or future environmental liabilities. The cost of any such obligations or
claims, whether we bear part or all of the cost, could materially adversely
affect our operating results and financial condition.

        We manage each affiliated partnership property according to a written
management contract. The managing general partner of the partnership may cancel
some contracts with 30 or 60 days' notice. A majority in interest of limited
partners in each partnership may take action on such matters as the removal of
the general partners, the request for approval or disapproval of a sale of a
property owned by a partnership, or other actions affecting the properties or
the partnership. Where we are the general partner of the partnership,
termination of the contracts generally would require removal of the Company as
general partner by the vote of a majority of the holders of limited partner
interests. We would lose management fees if those contracts were terminated.

        As guarantor for various obligations related to certain tax credit
properties we have funded and expect to fund additional amounts in the future.
See "-- Indebtedness, Lease and Other Obligations" and "Tax Credit Apartment
Properties."

DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYERS

        GeriCare was a former subsidiary of the Company that specialized in
rehabilitative services, including speech, occupational and physical therapy.
Although we disposed of GeriCare in 1998, revenue received or earned before it
was disposed that directly or indirectly was billed to the Medicare program is
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings, audits and funding restrictions. All could potentially
limit or reduce reimbursement levels for GeriCare's services.

        Medicare reimbursed GeriCare monthly for services provided on a cost
basis, subject to certain adjustments. GeriCare submitted cost reports to the
Health Care Financing Administration ("HCFA") on an annual basis and was subject
to having amounts previously reimbursed adjusted retroactively. The result of a
retroactive reimbursement would be either a requirement to repay the amount
previously reimbursed or an adjustment downward in future reimbursements for
services rendered, or both. We have submitted the required documents to HCFA for
an audit that began in October 1999, and have prepared cost reports that were
filed as of August 22, 1996 and thereafter. We have established an allowance for
amounts that we reasonably believe may be adjusted by HCFA, but there can be no
certainty that significant charges in addition to those provided for may be
denied, which could materially adversely affect our results of operations.

YEAR 2000 COMPLIANCE

        Information with respect to this subject is incorporated by reference to
the section entitled "Management's Discussion and Analysis".

GOVERNMENT REGULATION

        Assisted Living. Health care is subject to extensive regulation and
frequent regulatory change. Currently, no federal rules explicitly define or
regulate assisted living. A number of states also have not yet enacted specific
assisted living regulations. However, we are and will continue to be subject to
varying degrees of regulation and licensing by health or social service agencies
and other regulatory authorities in the various states and localities where we
operate or intend to operate. Changes in, or the adoption of, such laws and
regulations, or new interpretations of existing laws and regulations, could have
a significant effect on methods and costs of doing business, and on
reimbursement levels from governmental and other payers. In addition, the
President and Congress have proposed in the past, and may propose in future,
health care reforms that could impose additional regulations on the Company or
limit the amounts that we may charge for our services. We cannot assess the
ultimate timing and impact that any pending or future health care reform
proposals may have on the assisted living, home health care, skilled nursing or
health care industry in general. No assurance can be given that any such reform
will not have a material adverse effect on the business, financial condition or
results of operations of the Company.



                                       13
<PAGE>   14

        SSI Payments. A portion of our revenue comes from residents who receive
SSI payments. During 1999 we had 4% of our residents that were on the SSI
program. Revenue from these residents is generally lower than the amounts we
receive from our other residents and could be subject to payment delay. We
cannot assure that our percentage of revenue received from SSI will not
increase, or that the amounts paid by SSI programs will not be further limited.
In addition, if we were to become a provider of services under the Medicaid
program, we would be subject to Medicaid regulations designed to limit fraud and
abuse. Violations of these regulations could result in civil and criminal
penalties and exclusion from participation in the Medicaid program.

RISKS COMMON TO OUR ASSISTED LIVING OPERATIONS

        Staffing and Labor Costs. We compete with other providers of assisted
living and senior housing to attract and retain qualified personnel. We also
rely on the available labor pool of employees, and unemployment rates are very
low in many areas where we operate. We make a genuine effort to remain
competitive with other companies in our industry. Therefore, if it is necessary
for us to increase pay and/or enhance benefits to maintain our competitive
status in our industry, our labor costs could rise. We cannot provide assurance
that if our labor costs do increase, they can be matched by corresponding
increases in rental, assisted living or management revenue.

        Obtaining Residents and Maintaining Rates. As of December 31, 1999, the
ALCs we owned or operated had a combined occupancy rate of 88.7%.
Newly-developed ALCs may take longer to lease up than anticipated, causing them
to incur start-up losses for longer periods of time. We may revise our
construction schedules in order to phase in start-up losses from newly-developed
ALCs. Occupancy may drop in our existing ALCs, primarily due to:

        -       changes in the health of residents;

        -       increased competition from other assisted living providers,
                particularly those offering newer ALCs;

        -       the reassessment of residents' physical and cognitive state; and

        -       changes in management and staffing.

        We cannot assure that, at any time, any ALC will be substantially
occupied at assumed rents. In addition, we may only achieve lease-up and full
occupancy at rental rates below those assumed. If operating expenses increase,
local rental market conditions may limit the extent to which we may increase
prices. The implementation of rate increases for residents of new acquisitions
may lag behind increases in operating expenses. In addition, if we fail to
generate sufficient revenue, we may be unable to meet minimum rent obligations
under our long-term operating leases and to make interest and principal payments
on our indebtedness.

        General Real Estate Risks. The performance of our ALCs is influenced by
factors affecting real estate investments, including the general economic
climate. Other real estate risks include:

        -       an oversupply of, or a reduction in demand for, ALCs in a
                particular market;

        -       the attractiveness of properties to residents;

        -       zoning, rent control, environmental quality regulations or other
                regulatory restrictions;

        -       competition from other forms of housing;

        -       our ability to provide adequate maintenance and insurance; and

        -       our ability to control operating costs, including maintenance,
                insurance premiums and real estate taxes.

        At the time we acquire existing ALCs or open newly-developed ALCs, we
prepare budgets for known or expected rehabilitation expenses. We may incur
unknown or unforeseen rehabilitation or lease-up expenses. Real estate
investments are also affected by such factors as applicable laws, including tax
laws, interest rates and the availability of financing. Real estate investments
are relatively illiquid and, therefore, limit our ability to vary our portfolio
promptly in response to changes in economic or other conditions. If we fail to
integrate or operate acquired or developed ALCs effectively, it may have a
material adverse effect on our business, financial condition and operating
results.



                                       14
<PAGE>   15

        In addition, we currently lease ALCs from only four health care REITs.
The lease agreements with each REIT are interconnected in that we will not be
entitled to exercise our right to renew one lease with a particular landlord
without exercising our right to renew all other leases with that landlord. Also,
leases with each landlord contain certain cross default provisions. Therefore,
in order to exercise all lease renewal terms, we will be required to maintain
and rehabilitate the Leased ALCs on a long-term basis. We anticipate that
similar renewal and cross-default provisions will be included in leases with
other health care REITs or landlords.

        Bond Financing. We have entered into four long-term leases of ALCs, the
acquisition and construction of which have been or are being financed by tax
exempt multi-unit housing revenue bonds. In order to meet the lease obligations
and to allow the landlord to continue to qualify for favorable tax treatment of
the interest payable on the bonds, the ALC must comply with certain federal
income tax requirements. These requirements principally pertain to the maximum
income level of a specified portion of the residents. Should we elect to execute
additional leases for ALCs to be constructed with bond financing, the same and
possibly additional restrictions are anticipated to be imposed. Failure to
satisfy these requirements will constitute an event of default under the leases,
thereby permitting the landlord to accelerate their termination. Failure to
obtain low-income residents in the sequence and time required could materially
affect the lease-up schedule and, therefore, cash flow from such ALCs.

        Development and Construction Risks. As part of our business in 2000, we
are completing the development of the new ALCs. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation." Our ability to
achieve our development plans will depend upon a variety of factors, many of
which are beyond our control. The successful development of these ALCs involves
a number of risks, including the possibility that we may be delayed in or unable
to obtain necessary occupancy, licensing and other required governmental permits
and authorizations. We may change development schedules to meet staffing
requirements and to allow a phase-in of start-up losses inherent in the
marketing and lease-up of new ALCs. Certain construction risks are beyond our
control, including strikes, bad weather, natural disasters, supply of materials
and labor, and other unknown contingencies which could cause the cost and timing
of construction to exceed estimates. If we do not start or complete
construction, or subcontractors or suppliers are not paid, or if required
occupancy permits are not issued in a timely manner, cash flow could be
significantly reduced. In addition, any property under construction is subject
to the risks of construction defects, cost overruns, bad weather conditions, the
discovery of geological or environmental hazards on the property. The nature of
licenses and approvals necessary for development and construction, and the
timing and likelihood for obtaining them, varies widely from state to state and
community to community.

        Possible Environmental Liabilities. Under various federal, state and
local environmental laws, ordinances and regulations, a current or previous
owner or operator of real property may be held liable for the costs of the
removal or remediation of certain hazardous or toxic substances. These include,
without limitation, asbestos-containing materials which could be located on, in
or under such property. Such laws and regulations often impose liability whether
or not the owner or operator knows of, or is responsible for, the presence of
the hazardous or toxic substances. When we acquire land for development or
existing facilities, we typically obtain environmental reports on the properties
as part of our due diligence in order to lessen our risk of exposure.
Nonetheless, the costs of any required remediation or removal of these
substances could be substantial. The owner's liability is generally not limited
under such laws and regulations and could exceed the value of the property and
the aggregate assets of the owner or operator. The presence of these substances
or failure to remediate such substances properly may also adversely affect the
owner's ability to sell or rent the property or to borrow using the property as
collateral. Under these laws and regulations, an owner, operator, or any entity
that arranges for the disposal of hazardous or toxic substances at a disposal
site may also be liable for the costs of any required remediation or removal of
the hazardous or toxic substances at the disposal site. When entering into
leases with health care REITs and other landlords of facilities, we typically
enter into environmental indemnity agreements in which we agree to indemnify the
landlord against all risk of environmental liability, both during the term of
the lease and beyond. In connection with the ownership or operation of our
properties or those of our Affiliated Partnerships, we could be liable for these
costs, as well as certain other costs, including governmental fines and injuries
to persons or properties.

        Restrictions Imposed by Laws Benefiting Disabled Persons. Under the
Americans with Disabilities Act of 1990, all places of public accommodation are
required to meet certain federal requirements related to access and use by
disabled persons. A number of additional federal, state and local laws exist
that also may require us to modify existing and planned properties to allow
disabled persons to access the properties. We believe that our properties are
either substantially in compliance with present requirements or are exempt from
them, and we attempt to check for compliance in all ALCs we consider acquiring.
However, if required changes cost more than anticipated, or must be made sooner
than anticipated, we would incur additional costs. Further legislation may
impose additional burdens or restrictions related to access by disabled persons,
and the costs of compliance could be substantial.

        Geographic Concentration. A substantial portion of our business and
operations are conducted in California, where 39 of our ALCs in operation or
under construction are located. The market value of these properties and the
income generated from properties




                                       15
<PAGE>   16

        we manage or lease could be negatively affected by changes in local and
regional economic conditions, specific laws and the regulatory environment in
the states, and by acts of nature. We cannot provide assurance that such
geographic concentration will not have an adverse impact on our business,
financial condition, operating results and prospects.

        Insurance. We believe that we maintain adequate insurance coverage,
based on the nature and risks of our business, historical experience and
industry standards. Our business entails an inherent risk of liability. In
recent years, we and other assisted living providers have become subject to an
increasing number of lawsuits alleging negligence or related legal theories,
which may involve large claims and significant legal costs. From time to time we
are subject to such suits because of the nature of our business. We cannot
assure that claims will not arise that exceed our insurance coverage or are not
covered by it. A successful claim against us that is not covered by, or is in
excess of, our insurance could have a material adverse effect on our financial
condition, operating results or liquidity. Claims against us, regardless of
their merit or eventual outcome, may also have a material adverse effect on our
ability to attract residents or expand our business and would consume
considerable management time. We must renew our insurance policies annually and
can provide no assurance that we will be able to continue to obtain liability
insurance coverage in the future or that it will be available on acceptable
terms.

CONFLICTS OF INTEREST

        Certain of our current and former executive officers and Directors may
have an actual or potential conflict of interest with our interests. This
conflict may exist because of their investment in or involvement with entities
providing services, office space or guarantees to us, or to Company-sponsored
partnerships, or due to family ties with consultants offering services to us.
See "Certain Relationships and Related Transactions."

        In addition, we are the managing general partner and communities manager
for Affiliated Partnerships owning or leasing 16 ALCs and various apartment
communities. By serving in both capacities, we have conflicts of interest
because of our duty to act in the best interests of the limited partners of
those partnerships and our desire to maximize earnings for our stockholders in
the operation of those ALCs and apartment communities.

TAX CREDIT APARTMENT PROPERTIES

        As part of our plan to dispose of the Apartment Group, we may be
required to fund:

        -       obligations under development deficit guarantees and operating
                deficit guarantees;

        -       shortfalls in permanent loan financing to replace construction
                financing on projects where permanent financing has not been
                finalized; and

        -       adjustments if sufficient projected tax credits are not
                generated in order to meet agreed-upon levels of tax credit
                benefits.

        We have funded shortfalls through December 31, 1999, and have a
remaining provision of $5.3 million to fund estimated additional amounts due
under such arrangements.

ITEM 2. PROPERTIES

        The following charts set forth the location, number of units,
acquisition date and ownership for our communities as of December 31, 1999:


<TABLE>
<CAPTION>
                                                                                       MONTH            PERCENT
            COMMUNITY                                      LOCATION      UNITS        ACQUIRED         OWNERSHIP(a)
            ---------                                      --------      -----        --------         ------------
<S>                                                          <C>         <C>          <C>               <C>
            LEASED
            Amberwood ..............................          FL          183          Jun-96            100.0%
            Baypoint Village .......................          FL          231          Mar-96            100.0%
            Bayside Landing ........................          CA           76          Jun-98            100.0%
            Buena Vista Knolls .....................          CA           91          Feb-96            100.0%
            Canterbury Woods .......................          MA          130          Jun-98            100.0%
            Chateau San Juan .......................          CA          113          Dec-95            100.0%
            Collier Park ...........................          TX          159          Dec-96            100.0%
            Eastlake Terrace .......................          IN           93          Apr-97            100.0%
            El Camino Gardens ......................          CA          265          Jun-95            100.0%
            Hacienda de Monterey ...................          CA          180          Apr-94            100.0%
</TABLE>





                                       16
<PAGE>   17


<TABLE>
<CAPTION>
                                                                                       MONTH            PERCENT
            COMMUNITY                                      LOCATION      UNITS        ACQUIRED         OWNERSHIP(a)
            ---------                                      --------      -----        --------         ------------
<S>                                                         <C>          <C>          <C>               <C>
            Hillsdale Manor(c) .....................          CA          128          Jul-98            100.0%
            Inn at Summit Ridge ....................          NV           72          Apr-97            100.0%
            Inn at Willow Glen(b) ..................          CA           83          Aug-96             52.3%
            Kinghaven Manor ........................          MI          143          Feb-95            100.0%
            Lakes ..................................          FL          154          Dec-98            100.0%
            Lodge of Montgomery ....................          OH          214          Jan-97            100.0%
            Mallard Cove ...........................          OH          119          Feb-95            100.0%
            Maria del Sol ..........................          CA          124          Oct-95            100.0%
            Northgate Park .........................          OH          124          Aug-96            100.0%
            Rancho Park Villa ......................          CA          164          Oct-95            100.0%
            Shorehaven Manor .......................          MI          120          Sep-96            100.0%
            Seville Terrace ........................          NV          125          Dec-99            100.0%
            Sunlake Terrace ........................          NV          121          Feb-98            100.0%
            Sutton Terrace .........................          NV          142          Dec-98            100.0%
            Tamalpais Creek ........................          CA          120          Oct-95            100.0%
            Tanglewood Trace .......................          IN          159          Jan-97            100.0%
            Villa Bonita ...........................          CA          130          Oct-95            100.0%
            Villa Encinitas ........................          CA          117          Jun-95            100.0%
            Villa at Palm Desert ...................          CA           77          Nov-95            100.0%
            Villa de Palma .........................          CA          110          May-95            100.0%
            Villa del Obispo .......................          CA           95          May-95            100.0%
            Villa del Rey ..........................          CA          102          Jun-95            100.0%
            Villa del Sol ..........................          CA           91          Jun-95            100.0%
            Vista del Rio ..........................          NM          148          Jun-97            100.0%
            Willow Glen Villa ......................          CA          187          May-98            100.0%
            Woodside Village of Columbus ...........          OH          154          Feb-96            100.0%
                                                                        -----
                      Total Leased .................                    4,844
                                                                        =====
            OWNED
            Acacia Villa(b) ........................          CA           65          Dec-95             89.5%
            Collwood Knolls(b) .....................          CA          113          Jan-96             95.5%
            Covell Gardens .........................          CA          155          Mar-97            100.0%
            Covina Villa(b) ........................          CA           63          Aug-96             52.3%
            Golden Creek Inn .......................          CA          123          Apr-98            100.0%
            Hillcrest Inn ..........................          CA          138          Apr-98            100.0%
            Montego Heights Lodge(b) ...............          CA          162          Aug-96             52.3%
            Retirement Inn of Daly City(b) .........          CA           94          Aug-96             52.3%
            Retirement Inn of Fullerton(b) .........          CA           67          Aug-96             52.3%
            Retirement Inn of Burlingame(b) ........          CA           67          Aug-96             52.3%
            Retirement Inn of Campbell(b) ..........          CA           71          Aug-96             52.3%
            Retirement Inn of Fremont(b) ...........          CA           69          Aug-96             52.3%
            Retirement Inn of Sunnyvale(b) .........          CA          123          Aug-96             52.3%
            Valley View Lodge(b) ...................          CA          124          Aug-96             52.3%
            Villa Colima(b) ........................          CA           93          Jun-96             60.5%
                                                                        -----
                      Total Owned ..................                    1,527
                                                                        -----
                      Total Leased and Owned .......                    6,371
                                                                        =====
            MANAGED
            Altenheim (e) ..........................          CA          136          Apr-98
            Berkshire(d) ...........................          CA           81          Nov-98
            Bradford Square ........................          CA           92          Dec-90
            Chandler Villas ........................          AZ          164          Sep-90
            Encino Hills Terrace(d) ................          CA           76          Nov-98
            Sterling Court .........................          CA          149          Apr-98
            Villa Las Posas ........................          CA          123          Dec-97
                                                                        -----
                      Total Managed ................                      821
                                                                        -----
                      Total ........................                    7,192
                                                                        =====
</TABLE>


-------------------

(a)     Represents percentage ownership of Leased ALCs and Owned ALCs through
        leasehold or fee ownership of the Company or an Affiliated Partnership.

(b)     Community managed by us, owned or leased by Affiliated Partnership in
        which we have obtained a majority ownership interest.

(c)     We also acquired 64 beds in a skilled nursing facility, which is managed
        by a third-party, as part of this ALC.

(d)     Properties are owned by our unconsolidated joint ventures.

(e)     The management contract expired on December 31, 1999 and was not
        renewed.



                                       17
<PAGE>   18


        At December 31, 1999 we had the following projects under development and
construction and anticipate that the schedule set forth below can be met,
although there can be no assurance in this regard. Construction is subject to
numerous risks which could cause delays or the abandonment of a project or
projects. See "Risks Common to our Assisted Living Operations -- Development and
Construction Risks."


<TABLE>
<CAPTION>
                                                                              ANTICIPATED         ANTICIPATED
                                                          LOCATION            # OF UNITS          OPENING DATE
                                                          --------            ----------       -------------------
<S>                                                      <C>                   <C>            <C>
Lynnbrooke(a) ..................................          Irvine, CA              140          Second Quarter 2000
Bay Springs(a) .................................          Barrington, RI          126          Second Quarter 2000
Inn at Lakewood(a) .............................          Lakewood, CO            137          Third Quarter 2000
                                                                                -----
  Total units under development and construction                                  403
                                                                                =====
</TABLE>

----------

(a) We will manage these properties for our unconsolidated joint ventures with
    Vintage/ABR.

ITEM 3. LEGAL PROCEEDINGS

        On June 15, 1999, six California limited partnerships of which the
Company is the managing general partner and a majority limited partner -
American Retirement Villas Properties II, American Retirement Villas Properties
III, Casa Bonita Fullerton, Ltd., Collwood Knolls, L.P., and San Gabriel
Retirement Villa, L.P. (the "ARV Partnerships")-filed an action in the Superior
Court for the State of California, County of Orange, seeking a declaratory
judgment and damages for breach of contract, promissory estoppel, fraud and
negligent misrepresentation against PRN Mortgage Capital, L.L.C. and Red
Mountain Funding, L.L. C. (the "Defendants").

        The parties are in the initial states of discovery. Defendants have not
filed a counter-claim, but have threatened in verbal communications to seek
payment by the ARV Partnerships of certain loan commitment fees allegedly owed
to Defendants. The ARV Partnerships believe that they have substantial and
meritorious defenses to the counter-claims threatened by Defendants.

        We are from time to time subject to lawsuits and other matters in the
normal course of business. While we cannot predict the results with certainty,
we do not believe that any liability from any such lawsuits or other matters
will have a material effect on our financial position, results of operations, or
liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        We did not submit any matters to a vote of our security holders during
the fourth quarter of 1999.

                                     PART II


ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS

        Our Common Stock is listed and traded on the American Stock Exchange
under the symbol "SRS." Prior to October 13, 1997, our common stock was listed
on the NASDAQ National Market ("NASDAQ") under the symbol "ARVI." The following
table sets forth, for the periods indicated, the high and low closing prices for
our Common Stock.


<TABLE>
<CAPTION>
                                                                                     HIGH              LOW
                                                                                   --------          --------
<S>                                                 <C>                           <C>               <C>
Nine-Month Period Ended December 31, 1997
  First Quarter .........................            4/1/97  --   6/30/97          $  11.63          $   8.06
  Second Quarter ........................            7/1/97  --   9/30/97          $  12.75          $  10.25
  Third Quarter .........................           10/1/97  --  12/31/97          $  16.88          $  12.50
Year Ended December 31, 1998
  First Quarter .........................            1/1/98  --   3/31/98          $  16.13          $  12.88
  Second Quarter ........................            4/1/98  --   6/30/98          $  14.63          $  10.63
  Third Quarter .........................            7/1/98  --   9/30/98          $  12.31          $   6.38
  Fourth Quarter ........................           10/1/98  --  12/31/98          $   6.75          $   2.75
Year Ended December 31, 1999
  First Quarter .........................            1/1/99  --   3/31/99          $   6.25          $   3.94
  Second Quarter ........................            4/1/99  --   6/30/99          $   4.56          $   3.00
  Third Quarter .........................            7/1/99  --   9/30/99          $   4.06          $   2.44
  Fourth Quarter ........................           10/1/99  --  12/31/99          $   2.94          $   1.38
</TABLE>



                                       18
<PAGE>   19



        We do not currently pay dividends on our Common Stock and do not
anticipate paying dividends in the foreseeable future. It is the present policy
of our Board of Directors to retain earnings, if any, to finance the expansion
of our business.

VOLATILITY OF STOCK PRICE

        Sales of substantial amounts of shares of Common Stock in the public
market or the perception that those sales could occur could adversely affect the
market price of the Common Stock and our ability to raise additional funds in
the future in the capital markets. The market price of the Common Stock could be
subject to significant fluctuations in response to various factors and events,
including the liquidity of the market for the shares of the Common Stock,
variations in our operating results, changes in our earnings estimates and/or
securities analysts estimates, publicity regarding the industry or the Company
and the adoption of new statutes or regulations (or changes in the
interpretation of existing statutes or regulations) affecting the health care or
real estate industries in general or the assisted living industry in particular.
In addition, the stock market in recent years has experienced broad price and
volume fluctuations that often have been unrelated to the operating performance
of particular companies. These market fluctuations may adversely affect the
market price of the shares of Common Stock.

CONTROL BY DIRECTORS AND EXECUTIVE OFFICERS; ANTI-TAKEOVER MEASURES

        As of December 31, 1999, our Directors and executive officers and their
affiliates beneficially own approximately 48.8% of our outstanding shares of
Common Stock (exclusive of unexercised options to purchase shares of Common
Stock). As a result, these stockholders, acting together, would be able to
significantly influence many matters requiring approval by our stockholders,
including the election of Directors. Our articles of incorporation provide for
authorized but unissued preferred stock, the terms of which may be fixed by our
Board of Directors. As a result of Delaware General Corporation Law relating to
the number of holders of Common Stock, our Board of Directors are classified and
the holders of Common Stock are not permitted to cumulate votes. Such provisions
could have the effect of delaying, deferring or preventing a change of control
of the Company.

        In May 1998, we adopted a stockholders rights plan, under Delaware law,
under which we declared a dividend distribution of one Preferred Share Purchase
Right on each outstanding share of our common stock. Subject to limited
exceptions, the Rights will be exercisable if a person or group acquires 10% or,
in the case of LFREI, 50% or more of our stock or announces a tender offer for
10% or, in the case of LFREI, 50% or more of the common stock. When exercisable,
each Right will entitle its holder to purchase, at the Right's then-current
exercise price, a number of our common shares having a market value at the time
of twice the Right's exercisable price. If we are acquired in a merger or other
business combination transaction which has not been approved by our Board of
Directors, each Right (except the Rights held by the acquiring person) will
entitle its holder to purchase, at the Right's then-current exercise price, a
number of our common shares having a market value at that time of twice the
Right's exercise price.

ITEM 6. SELECTED FINANCIAL DATA

      The following selected financial data has been derived from our audited
consolidated financial statements as of December 31, 1999, and December 31,
1998, and the years then ended; December 31, 1997, and the nine-month period
then ended; and for each of the two fiscal years ended March 31, 1997. The data
set forth below should be read in conjunction with the consolidated financial
statements and related notes thereto included in Item 14, "Exhibits, Financial
Statement Schedules and Reports on Form 8-K -- Financial Statements," along with
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations."


<TABLE>
<CAPTION>
                                                                                  NINE-MONTH          FISCAL YEAR ENDED
                                                  YEAR ENDED       YEAR ENDED     PERIOD ENDED             MARCH 31,
                                                  DECEMBER 31,    DECEMBER 31,    DECEMBER 31,     ------------------------
                                                     1999             1998            1997            1997           1996
                                                  ------------    ------------    ------------     ---------      ---------
                                                               (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                               <C>             <C>              <C>            <C>            <C>
Consolidated Statement of Operations Data:
Revenue:
  Assisted living community revenue .........      $ 137,176       $ 127,309       $  76,887       $  73,770      $  25,479
  Management fees ...........................          1,003           1,116             388           1,141          2,536
                                                   ---------       ---------       ---------       ---------      ---------
        Total revenue .......................        138,179         128,425          77,275          74,911         28,015
                                                   ---------       ---------       ---------       ---------      ---------
Operating expenses:
  Assisted living community operating expense         87,665          81,487          49,411          45,595         16,395
  Assisted living community lease expense ...         32,239          26,628          15,773          12,872          6,644
  General and administrative ................         13,965          27,181          17,595           9,097          7,705
  Impairment loss ...........................         16,368          22,728              --              --             --
  Depreciation and amortization .............          8,531           9,561           4,896           4,366          1,031
                                                   ---------       ---------       ---------       ---------      ---------
        Total operating expenses ............        158,768         167,585          87,675          71,930         31,775
                                                   ---------       ---------       ---------       ---------      ---------
        Income (loss) from operations .......        (20,589)        (39,160)        (10,400)          2,981         (3,760)
                                                   ---------       ---------       ---------       ---------      ---------
Other income (expense):
  Interest income ...........................          1,027           2,276           1,821           1,668          1,071
</TABLE>



                                       19
<PAGE>   20


<TABLE>
<S>                                               <C>             <C>              <C>            <C>            <C>
  Other income, net .........................            376             198             321           1,402          2,203
  Gain (loss) on sale .......................             --            (674)          5,511              --             --
  Interest expense ..........................         (8,933)         (7,728)         (4,568)         (5,470)        (1,362)
  Litigation judgment .......................         (4,368)             --              --              --             --
                                                   ---------       ---------       ---------       ---------      ---------
        Total other income (expense) ........        (11,898)         (5,928)          3,085          (2,400)         1,912
                                                   ---------       ---------       ---------       ---------      ---------
  Income (loss) from continuing operations
    before income taxes .....................        (32,487)        (45,088)         (7,315)            581         (1,848)
  Income tax expense (benefit) ..............             35              54             484             297            233
                                                   ---------       ---------       ---------       ---------      ---------
  Income (loss) from continuing operations
    before minority interest in Income of
    majority owned entities, discontinued
    operations and Extraordinary item .......        (32,522)        (45,142)         (7,799)            284         (2,081)
Minority interest in income of majority
    owned entities ..........................            903             839             773             783             --
                                                   ---------       ---------       ---------       ---------      ---------
Loss from continuing operations .............        (33,425)        (45,981)         (8,572)           (499)        (2,081)
  Income (loss) from discontinued operations,
    net of income tax .......................             --              --         (13,563)           (889)         1,116
  Early extinguishment of debt, net of
    income tax ..............................          7,020              --              --            (386)            --
                                                   ---------       ---------       ---------       ---------      ---------
   Loss from continuing operations before
    change  in accounting principle .........        (26,405)        (45,981)        (22,135)         (1,774)          (965)
      Cumulative effect of  change in
           accounting principle, net of tax .          1,260
        Net loss ............................        (27,665)        (45,981)        (22,135)         (1,774)          (965)
Preferred dividends declared ................             --              --              --              --            351
                                                   ---------       ---------       ---------       ---------      ---------
Net loss available for common shares(1) .....      $ (27,665)      $ (45,981)      $ (22,135)      $  (1,774)     $  (1,316)
                                                   =========       =========       =========       =========      =========
Basic and diluted loss per common share:
  Loss from continuing operations ...........      $   (2.09)      $   (2.90)      $   (0.77)      $    (.05)     $    (.39)
  Income (loss) from discontinued operations              --              --           (1.21)           (.10)           .18
  Gain (loss)  from extraordinary item ......           0.44              --              --            (.04)            --
  Loss from cumulative effect of change in
    accounting principle, net of tax ........           (.08)             --              --              --             --
                                                   ---------       ---------       ---------       ---------      ---------
        Net loss ............................      $   (1.73)      $   (2.90)      $   (1.98)      $    (.19)     $    (.21)
                                                   =========       =========       =========       =========      =========
Weighted average common
    shares outstanding(1) ...................         15,968          15,866          11,171           9,400          6,246
                                                   =========       =========       =========       =========      =========
</TABLE>


<TABLE>
<CAPTION>
                                                                    DECEMBER 31,                             MARCH 31,
                                                     ---------------------------------------         -----------------------
                                                      1999            1998             1997            1997            1996
                                                     -------         -------         -------         -------          ------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                 <C>             <C>             <C>             <C>             <C>
Selected Operating Data:
Assisted living units owned or leased
    (end of period) .........................          6,371           7,038           5,880           5,599           3,277
Assisted living units managed
    (end of period) .........................            821             906             379             256           1,289
Weighted average occupancy of assisted living
    units (end of year) .....................             85%             84%             84%             87%             90%
Balance Sheet Data:
Working capital (deficit) ...................       $  6,870        $ 11,691        $ 75,279        $ 12,947        $ 10,014
    Total assets ............................        173,287         205,457         233,085         161,947          77,403
Long-term notes payable, excluding current
    portion .................................        114,369          88,175          81,560          90,481          24,814
Series A Preferred Stock, convertible
    and Redeemable ..........................             --              --              --              --           2,358
    Total stockholders' equity (deficit) ....         39,124          65,687         111,435          51,374          39,947
</TABLE>


---------------------

(1)     Net loss available for common shares reflects the effect of preferred
        stock dividends. Weighted average common shares outstanding give effect
        to the 1 for 3.04 reverse stock split which occurred upon the completion
        of the Initial Public Offering.

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

        The Selected Financial Data in Item 6 and the consolidated financial
statements included in this Annual Report on Form 10-K set forth certain data
with respect to our financial position, results of operations and cash flows
that should be read in conjunction with the following discussion and analysis.

OVERVIEW

        We are a leading national provider of assisted and independent living
services for the elderly. As of December 31, 1999, we operated 58 ALCs
containing 7,192 units, including 36 Leased ALCs, 15 Owned ALCs and 7 Managed
ALCs. Additionally, we are in various stages of construction and development on
3 ALCs with an anticipated total of 403 units.

        Since commencing operation of ALCs for our own account in April 1994, we
embarked upon an expansion strategy and achieved significant growth in revenue
resulting primarily from the acquisition of ALCs. We focused our growth efforts
on the acquisition and development of additional ALCs and expansion of services
to our residents as they "age in place." During 1998, we acquired interests in
11 ALCs and one skilled nursing facility from Hillsdale Group, LP and their
affiliates, and opened five newly constructed ALCs. As of December 31, 1999, a
substantial portion of our business and operations are conducted in California,
where 39 of the 58 ALCs we operated were located. We intend to continue to make
the western United States the primary focus of our clustering strategy. However,
we intend to reduce our prior growth rate in order to focus greater attention
and resources on enhancing the profitability of our existing core operations and
on leasing up new developments at a faster rate. In addition we plan to divest
ALCs that do not



                                       20
<PAGE>   21


expand or enhance one of our geographic clusters or do not meet our financial
objectives. Therefore in March 1999 we completed the sale of three ALCs and in
June we completed the sale of one ALC. In October 1999 we completed the sale of
one ALC and two of the five land sites held for sale. In December 1999, we
received letters of intent to purchase twelve of the leased ALCs outside of the
western United States. This was in addition to the five owned ALCs and five land
sites previously held for sale in 1998.

        In March 1999, ARVP II obtained financing and, through its wholly owned
subsidiary ARVP II, LLC, purchased the landlord's interest in four previously
leased ALCs for approximately $14.3 million. On March 26, 1999, Douglas M.
Pasquale, our President and Chief Operating Officer, was named our Chief
Executive Officer, and on March 30, 1999, Abdo H. Khoury, our Vice President of
Asset Strategy and Treasurer, was promoted to Senior Vice President and Chief
Financial Officer. Effective December 22, 1999 Douglas M. Pasquale was named
Chairman of our Board of Directors.

        On June 28, 1999, we refinanced 11 properties held by various
partnerships that had under-leveraged assets through Banc One. As the general
partner of the partnerships we distributed most of the contributed capital from
the refinancing to the limited partners and enhanced our liquidity position in
the partnerships. The term of the loans is two years with a lender optional
10-year extension and a 25-year amortization schedule for repayment of
principal, fixed interest of 9.15% and a 2% structuring fee for Banc One that is
amortized over two years

        In our fiscal year ended December 31, 1999, we began retiring portions
of our 6 3/4% convertible subordinated debt from time to time. During that
fiscal year, we issued a total of 799,566 shares of our common stock and paid a
total of $1.0 million to some of our bondholders in exchange for a total of $9.2
million principal amount of the subordinated notes due 2006 that were held by
those bondholders. These transactions resulted in an extraordinary gain of $6.8
million net of tax as of our fiscal year ended December 31, 1999. During the
current fiscal year, we have issued a total of 781,025 share of our common stock
and paid a total of $0.9 million to additional bondholders in exchange for a
total of $7.8 million additional principal amount of the subordinated notes held
by those bondholders. These additional transactions resulted in an extraordinary
gain of $5.6 million net of tax as of March 21, 2000. Through these
transactions, we have retired a total of $17.1 million of our public debt
resulting in extraordinary gains of $12.4 million to date.

        Newly opened ALCs are expected to incur operating losses until
sufficient occupancy levels and operating efficiencies are achieved. Based upon
recent experience, we believe that a typical community will achieve its targeted
occupancy levels 18-24 months from the commencement of operations. Accordingly,
we will require substantial amounts of liquidity to maintain the operations of
newly opened ALCs. If sufficient occupancy levels are not achieved within
reasonable periods, our results of operations, financial position and liquidity
could be materially and adversely impacted.


THE YEAR ENDED DECEMBER 31, 1999 COMPARED WITH DECEMBER 31, 1998

        The following table sets forth a comparison of the year ended December
31, 1999 and the year ended December 31, 1998.


<TABLE>
<CAPTION>
                                                                       FOR THE            FOR THE
                                                                      YEAR ENDED         YEAR ENDED
                                                                      DECEMBER 31,       DECEMBER 31,       INCREASE/
                                                                         1999               1998            (DECREASE)
                                                                      ------------       ------------       ----------
                                                                                 (DOLLARS IN MILLIONS)
<S>                                                                     <C>                <C>                   <C>
               Revenue:
                 Assisted living community revenue .........            $137.2             $127.3                7.8%
                 Management fees from affiliates and others                1.0                1.1              (10.1)%
                                                                        ------             ------
                         Total revenue .....................             138.2              128.4                7.6%
                                                                        ------             ------
               Operating expenses:
                 Assisted living community operating expense              87.7               81.5                7.6%
                 Assisted living community lease expense ...              32.2               26.6               21.1%
                 General and administrative ................              14.0               27.2              (48.6)%
                 Impairment loss ...........................              16.4               22.7              (28.0)%
                 Depreciation and amortization .............               8.5                9.6              (10.8)%
                                                                        ------             ------
                         Total operating expenses ..........             158.8              167.6               (5.3)%
                                                                        ------             ------
               Loss from operations ........................             (20.6)             (39.2)             (47.4)%
                                                                        ------             ------
               Other income (expense):
                 Interest income ...........................               1.0                2.3              (54.9)%
                 Other income, net .........................               0.4                0.2               58.0%
                 Gain (loss) on sale .......................                --               (0.7)            (100.0)%
                 Interest expense ..........................              (8.9)              (7.7)              15.6%
                 Litigation judgment .......................              (4.4)                --              100.0%
                                                                        ------             ------
                         Total other income (expense) ......             (11.9)              (5.9)             102.1%
                                                                        ------             ------
</TABLE>



                                       21
<PAGE>   22


<TABLE>
<S>                                                                     <C>               <C>                <C>
               Loss from continuing operations before
               income taxes, minority interest in income
               of majority owned entities, extraordinary
               items, discontinued operations and change
               in accounting principle .....................             (32.5)             (45.1)             (27.9)%
               Income tax expense ..........................                --                0.1               35.2%
                                                                        ------             ------
               Loss from continuing operations before
                 minority interest in income of majority
                 owned entities, extraordinary items,
                 discontinued operations and change in
                 accounting principle ......................             (32.5)             (45.2)             (27.9)%
               Minority interest in income of majority
                 owned entities ............................               0.9                0.8                7.6%
                                                                        ------             ------
               Loss from continuing operations before
                 extraordinary item, discontinued
                 operations and change in
                 accounting principle ......................             (33.4)             (46.0)             (27.2)%
               Extraordinary gain  from early
                 extinguishment of debt ....................               7.0                 --              100.0%
                                                                        ------             ------
               Loss before cumulative effect of
                 acctg. change .............................             (26.4)             (46.0)             (42.5)%
               Cumulative effect of acctg. change ..........              (1.3)                --              100.0%
                                                                        ------             ------
                    Net loss ...............................            $(27.7)            $(46.0)             (39.8)%
                                                                        ======             ======
</TABLE>

        The increase of $9.9 million in assisted living community revenue is
attributable to:

        -       the acquisition of seven ALCs during the second and third
                quarters of 1998, offset somewhat by the sale of three
                communities in March 1999, the sale of one ALC in June 1999 and
                the sale of one ALC in October 1999;

        -       the five ALCs opened in the latter part of 1998 were generating
                revenues though still in a "lease up" stage with occupancies in
                the 50% range during 1999;

        -       the increase in average occupancy for same store ALCs to 86.7%
                for 1999 as compared with 85.7% for 1998;

        -       the increase in assisted living penetration to 45.6% for 1999 as
                compared with 43.5% for 1998; and

        -       the increase in average rate per occupied unit to $2,070 for
                1999 as compared with $1,828 for 1998.

        Management fees from affiliates and others decreased $0.1 million due
to:

        -       the number of management contracts decreased to seven in 1999
                from eight in 1998.

        Assisted living community operating expense increased $6.2 million due
to:

        -       the acquisition of seven ALCs during the second and third
                quarters of 1998, offset somewhat by the sale of three
                communities in March 1999, the sale of one ALC in June 1999 and
                the sale of one ALC in October 1999;

        -       the five newly opened ALCs in 1998 have full year expenses in
                1999 compared to a partial year in 1998;

        -       the opening of one ALC in November 1999;

        -       staffing requirements related to increased assisted living
                services provided; and

        -       increased wages of staff.

        The increase in assisted living community lease expense of $5.6 million
is primarily due to:

        -       the acquisition of two leased ALCs during the second and third
                quarters of 1998, offset somewhat by the acquisition of four
                previously leased communities; and

        -       the opening of five ALCs during the latter half of 1998 which
                incurred only a partial year of lease expense while 1999 has the
                full year.

        General and administrative expenses decreased $13.2 million due to the
following:

        -       expenses incurred in connection with the lawsuits with Kapson,
                Atria and LFREI and Emeritus were substantially less in 1999
                Year than 1998 Year as we settled the lawsuits in the middle of
                1999;



                                       22
<PAGE>   23

        -       in 1999 Year there were substantially less severance payments
                related to changes in management personnel than experienced in
                1998 Year;

        -       in 1999 Year there were no investment banking fees, compared to
                $1.7 million in 1998; and

        -       in 1999 Year we made substantial reductions in staffing under
                the new management team.

        The impairment loss in 1998 Year was due to:

        -       a $19.0 million write-down of five existing ALCs and five land
                sites held for sale that had carrying values in excess of fair
                market value; and

        -       a $3.7 million impairment loss on existing ALCs which had
                projected future cash flows that were less than carrying value
                of the assets.

        While the impairment loss in 1999 Year was due to:

        -       an $8.6 million impairment loss which represents a write down of
                the carrying values in excess of fair market value of the
                property held for sale; and

        -       a $7.7 million write off for Rossmore House which included $3.1
                million and $4.6 million for reduction in carrying value.

        Depreciation and amortization expenses decreased due to sale of ALCs
during 1999.

        Interest income decreased due to lower average cash balances carried by
us during 1999 as compared to 1998.

        Interest expense increased $1.2 million due to:

        -       decrease for interest rate lock and commitment fees incurred in
                connection with the failed refinance of the majority owned
                entities during 1998; offset by

        -       increase due to additional debt incurred in connection with
                acquiring four ALCs in the first quarter of 1999;

        -       increase due to partial versus full year of interest expenses
                for the ALCs acquired in 1998; and

        -       increase due to refinancing 11 owned properties in June 1999.

        Minority interest in income of majority owned entities decreased due to:

        -       interest expense for the four acquired ALCs which were
                previously leased;

        -       interest expense for the 9 refinanced properties; and offset by

        -       no interest rate lock or commitment fees paid as were paid in
                1998.

        Loss from discontinued operations decreased as all expected future
operating costs for our discontinued operations were recorded in the 1997
Period. No additional costs have been incurred during the 1999 or 1998 year.

THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED WITH THE NINE-MONTH PERIOD
ENDED DECEMBER 31, 1997

        The following table sets forth a comparison of the fiscal year ended
December 31, 1998 ( the "1998 Year") compared to the nine-month period ended
December 31, 1997 (the "1997 Period") .




                                       23
<PAGE>   24


<TABLE>
<CAPTION>
                                                                                                  FOR THE
                                                                               FOR THE           NINE-MONTH
                                                                              YEAR ENDED        PERIOD ENDED
                                                                              DECEMBER 31,       DECEMBER 31,         INCREASE/
                                                                                  1998               1997            (DECREASE)
                                                                              ------------      -------------        ----------
                                                                                           (DOLLARS IN MILLIONS)
<S>                                                                              <C>                <C>                  <C>
               Revenue:
                 Assisted living community revenue ..................            $127.3             $ 76.9               65.8%
                 Management fees from affiliates and others .........               1.1                0.4              187.6%
                                                                                 ------             ------             ------
                         Total revenue ..............................             128.4               77.3               66.4%
                                                                                 ------             ------             ------
               Operating expenses:
                 Assisted living community operating expense ........              81.5               49.4               64.4%
                 Assisted living community lease expense ............              26.6               15.8               68.8%
                 General and administrative .........................              27.2               17.6               53.8%
                 Impairment loss ....................................              22.7                 --              100.0%
                 Depreciation and amortization ......................               9.6                4.9               95.3%
                                                                                 ------             ------             ------
                         Total operating expenses ...................             167.6               87.7               90.7%
                                                                                 ------             ------             ------
               Loss from operations .................................             (39.2)             (10.4)             271.8%
                                                                                 ------             ------             ------
               Other income (expense):
                 Interest income ....................................               2.3                1.8               27.8%
                 Other income, net ..................................               0.2                0.3              (28.7)%
                 Gain (loss) on sale ................................              (0.7)               5.5             (112.2)%
                 Interest expense ...................................              (7.7)              (4.5)              74.2%
                                                                                 ------             ------             ------
                         Total other income (expense) ...............              (5.9)               3.1             (308.3)%
                                                                                 ------             ------             ------
               Loss from continuing operations before income taxes ..             (45.1)              (7.3)             516.4%
               Income tax expense ...................................               0.1                0.5              (88.8)%
                                                                                 ------             ------             ------
               Loss from continuing operations before minority
                 interest in income of majority owned entities
                 and discontinued
                 operations .........................................             (45.2)              (7.8)             478.8%
               Minority interest in income of majority owned entities               0.8                0.8                8.5%
                                                                                 ------             ------             ------
               Loss from continuing operations ......................             (46.0)              (8.6)             436.4%
               Loss from operations of discontinued operations ......                --              (13.5)            (100.0)%
                                                                                 ------             ------             ------
                    Net loss ........................................            $(46.0)            $(22.1)             107.7%
                                                                                 ======             ======             ======
</TABLE>


        The increase in assisted living community revenue is attributable to:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period;

        -       the acquisition of seven Owned and Leased ALCs during the 1998
                Year;

        -       the opening of five Leased ALCs during the 1998 Year;

        -       the increase in average occupancy for all of our Owned and
                Leased ALCs to 85.7% for the 1998 Year as compared with 83.8%
                for the 1997 Period;

        -       the increase in assisted living penetration to 43.5% for the
                1998 Year as compared with 37.8% for the 1997 Period; and

        -       the increase in average rate per occupied unit to $1,828 for the
                1998 Year as compared with $1,679 for the 1997 Period.

        Management fees from affiliates and others increased due to:

        -       1998 having 12 months as compared to 9 months in the 1997
                Period; and

        -       the increased number of management contracts to seven in the
                1998 Year from three in the 1997 Period.

        Assisted living community operating expense increased due to:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period;

        -       the acquisition of seven Owned and Leased ALCs during 1998;

        -       the opening of five Leased ALCs during 1998;

        -       staffing requirements related to increased assisted living
                services provided; and



                                       24
<PAGE>   25


        -       increased wages of staff.

        The increase in assisted living community lease expense is primarily due
to:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period; and

        -       the acquisition of two Leased ALCs and the opening of five
                Leased ALCs during the 1998 Year.

        General and administrative expenses increased due to the following:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period;

        -       expenses incurred in connection with the lawsuits with Kapson,
                Atria and LFREI;

        -       severance payments related to our changes in management
                personnel;

        -       investment banking fees; and

        -       additional staffing necessary to accommodate the increased
                operations during the 1998 Year.

        Depreciation and amortization expenses increased due to:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period; and

        -       the acquisition of seven Owned and Leased ALCs during the 1998
                Year.

        Interest income increased due to 12 months included in the 1998 Year as
compared to 9 months in the 1997 Period, offset by, lower average cash balances
carried by us during the 1998 Year as compared to the 1997 Period.

        Other income remained constant for the 1998 Year as compared to the 1997
Period.

        The impairment loss is due to:

        -       a $19.0 million write-down of five existing ALCs and five land
                sites held for sale that had carrying values in excess of fair
                market value; and

        -       a $3.7 million impairment loss on existing ALCs which had
                projected future cash flows that were less than carrying value
                of the assets.

        Interest expense increased due to:

        -       additional debt assumed in connection with the acquisition of
                two Owned ALCs during the 1998 Year; and

        -       $1.5 million of interest rate lock and commitment fees incurred
                in connection with the failed refinance of the majority owned
                entities during the 1998 Year.

        Minority interest in income of majority owned entities increased due to:

        -       the 1998 Year having 12 months as compared to 9 months in the
                1997 Period;

        -       in the 1997 Period we allocated losses from a limited liability
                corporation ("LLC") to the minority owner. We sold our interest
                in the LLC in December 1997; offset by:

        -       interest rate lock and commitment fees paid by the majority
                owned entities during the 1998 Year.



                                       25
<PAGE>   26

        Loss from discontinued operations decreased as all expected future
operating costs for our discontinued operations were recorded in the 1997
Period. No additional costs have been incurred during the 1998 Year.


LIQUIDITY AND CAPITAL RESOURCES

        Our unrestricted cash and cash equivalents balances were $14.6 million
and $11.9 million at December 31, 1999 and 1998, respectively.

        Working capital decreased to $10.1 million as of December 31, 1999
compared to working capital of $11.7 million at December 31, 1998, resulting
primarily from loss from operations.

        During 1999 cash used in continuing operations was $10.1 million
compared to $9.5 million during the 1998 Year and $3.1 million in the 1997
Period.

        The cash used in operating activities during 1999 was a result of:

        -       our net loss of $27.7 million; offset by:

        -       $0.6 million of cash provided by operating activities of
                discontinued operations;

        -       non-cash charges of:

                --      $16.4 million loss recorded for impairment of long-lived
                        assets;

                --      $8.5 million of depreciation and amortization expense;

                --      $0.9 million of minority interest in income of majority
                        owned entities;

                --      $7.0 million for gain on extraordinary item on early
                        extinguishment of debt;

                _       $2.6 million increase in net liabilities;

                _       $1.3 million for the cumulative effect of the change in
                        accounting principle.

        The cash used in operating activities during the 1998 Year was a result
of:

        -       our net loss of $46.0 million;

        -       $3.4 million of cash used in operating activities of
                discontinued operations; offset by:

        -       non-cash charges of:

                --      $22.7 million loss recorded for impairment of long-lived
                        assets;

                --      $9.6 million of depreciation and amortization expense;

                --      $0.8 million of minority interest in income of majority
                        owned entities;

                --      $0.7 million of losses recorded on properties sold to
                        our development joint ventures;

                --      $0.6 million of provisions for doubtful accounts.

                --      $2.0 million increase in net liabilities.

        The cash used in operating activities during the 1997 Period was a
result of:



                                       26
<PAGE>   27


        -       our net loss of $22.1 million;

        -       $4.3 million of cash used in operating activities of
                discontinued operation;

        -       $5.5 million of non-cash gain from the sale of our 50% interest
                in two LLCs; offset by:

        -       non-cash charges of:

                --      $13.6 million loss related to discontinued operations;

                --      $4.9 million of depreciation and amortization expense;

                --      $0.8 million of minority interest in income of majority
                        owned entities;

                --      $0.6 million of provisions for doubtful accounts.

        -       $4.6 million increase in net liabilities.

        In 1999 cash provided by investing activities was $10.1 million as
compared to $78.1 million of cash used in 1998 and $11.8 million provided by the
1997 Period.

        The cash provided by investing activities during 1999 was a result of:

        -       $ 39.7 million proceeds for sale of ALCs, net of cost; offset
                by:

        -       $14.7 million for purchase of previously leased ALCs;

        -       $7.4 million for purchase of property, furniture and equipment;

        -       $6.4 million increase in security deposit on leased properties;
                and

        -       $1.3 million for the contribution into the joint venture.

        The cash used in investing activities during the 1998 Year was a result
of:

        -       $71.7 million related to the acquisition of five Owned ALCs, two
                Leased ALCs and four management contracts;

        -       $12.3 million of purchases of property, furniture and equipment;

        -       $1.3 million of payments to increase cash security deposits on
                our leased ALCs;

        -       $0.7 million for costs associated with development properties,
                investments in joint ventures and a deposit related to the
                purchase of additional ALCs; offset by:

        -       $7.2 million of net proceeds received from the sale of two Owned
                ALCs and two land sites to our development joint ventures; and

        -       $0.7 million distribution received from our investment in Senior
                Income Fund LP.

        The cash provided by investing activities during the 1997 Period was a
result of:

        -       $24.2 million from the sale of our 50% interests in two LLCs;

        -       $3.6 million distributions received from our investment in
                Senior Income Fund LP;



                                       27
<PAGE>   28

        -       $1.9 million of proceeds from the sale and leaseback of
                communities;

        -       $1.7 million release of restricted cash as collateral for
                letters of credit pledged as security deposits of Leased ALCs;
                offset by:

        -       $18.6 million of purchases of property, furniture and equipment;

        -       $0.5 million for the purchase of units in Senior Income Fund LP;

        -       $0.3 million of payments to increase cash security deposits on
                our leased ALCs; and

        -       $0.1 million for costs associated with development properties;

        In 1999 the cash provided by financing activities was $2.1 million as
compared to $0.2 million for 1998 and $82.6 million during the 1997 Period.

        The cash provided by financing activities during 1999 was a result of:

        -       $41.8 million refinancing proceeds;

        -       $14.7 million of borrowing under note payables for purchase of
                previously leased ALCs;

        -       $2.6 million of borrowing under note payables; offset by:

        -       $45.2 million of repayments of notes payable;

        -       $9.0 million of distributions paid to our minority partners in
                certain majority owned entities; and

        -       $1.8 million of loan fees.

        The cash provided by financing activities during 1998 was a result of:

        -       $4.4 million additional draw on a note payable;

        -       $0.2 million of proceeds received from issuance of common stock;
                offset by:

        -       $2.6 million for issuance costs associated with our conversion
                of the Prometheus Notes;

        -       $0.8 million of distributions paid to our minority partners in
                certain majority owned entities;

        -       $0.7 million of repayments of notes payable;

        -       $0.3 million of payments for loan and line of credit fees.

        The cash provided by financing activities during the 1997 Period was a
result of:

        -       $60.0 million proceeds from the issuance of the Prometheus
                Notes;

        -       $24.8 million of proceeds received from issuance of common
                stock, net of issuance costs; offset by:

        -       $1.5 million of repayments of notes payable; and

        -       $0.7 million of distributions paid from our majority owned
                entities.

On September 10, 1996, we obtained a $10 million revolving line of credit with
Imperial Bank to be used for acquisition, development, the provision of letters
of credit and general corporate purposes. On November 10, 1998, Imperial amended
the line of



                                       28
<PAGE>   29

credit agreement to require that we provide collateral for outstanding standby
letter of credit obligations. As of December 31, 1999 we no longer had any
credit facility and had fully collateralized our outstanding standby letter of
credit with cash.

        We believe that our existing liquidity, ability to sell ALCs and land
sites which do not meet our financial objectives or geographic strategy, and
ability to refinance certain Owned ALCs and investments will provide adequate
resources to meet our current operating and investing needs and support our
current growth plans for the next 12 months. We do not currently generate
sufficient cash from operations to fund recurring working capital requirements.
We will be required from time to time to incur additional indebtedness or issue
additional debt or equity securities to finance our growth strategy, including
the acquisition and development of ALCs as well as other capital expenditures
and to provide additional funds to meet increased working capital requirements.


IMPACT OF INFLATION AND CHANGING PRICES

        Operating revenue from ALCs we operate is the primary source of our
revenue. These ALCs are affected by rental rates which are highly dependent upon
market conditions and the competitive environments where the communities are
located. Employee compensation is the principal cost element of property
operations. Although there can be no assurance we will be able to continue to do
so, we have been able historically to offset the effects of inflation on
salaries and other operating expenses by increasing rental and assisted living
rates.


YEAR 2000

Our Year 2000 program, implemented worldwide under the direction of our senior
management, was completed on schedule. We did not experience any significant
operational issues nor did our residents experience any problems at our ALCs.
The total cost of our Year 2000 program is approximately $2.0 million. We are
not aware of any obligations related to damages resulting from Year 2000 issues.
We do not believe that any such obligations that may arise in the future will
have a material effect on our business, results of operations, financial
position or liquidity.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to market risks related to fluctuations in interest rates
on our notes payable. Currently, we do not utilize interest rate swaps. The
purpose of the following analysis is to provide a framework to understand our
sensitivity to hypothetical changes in interest rates as of December 31, 1999.
You should be aware that many of the statements contained in this section are
forward looking and should be read in conjunction with our disclosures under the
heading "Forward-Looking Statements."

        For fixed rate debt, changes in interest rates generally affect the fair
market value of the debt instrument, but not our earnings or cash flows.
Conversely, for variable rate debt, changes in interest rates generally do not
impact fair market value of the debt instrument, but do affect our future
earnings and cash flows. We do not have an obligation to prepay fixed rate debt
prior to maturity, and as a result, interest rate risk and changes in fair
market value should not have a significant impact on the fixed rate debt until
we would be required to refinance such debt. Holding the variable rate debt
balance constant, each one-percentage point increase in interest rates would
result in an increase in variable rate interest incurred for the coming year of
approximately $256,000.

        The table below details the principal amount and the average interest
rates of notes payable in each category based upon the expected maturity dates.
The fair value estimates for notes payable are based upon future discounted cash
flows of similar type notes or quoted market prices for similar loans. The
carrying value of our variable rate debt approximates fair value due to the
frequency of re-pricing of this debt. Our fixed rate debt consists of
convertible subordinated notes payable and mortgage payables. The fixed rate
debt bears interest at rates that approximate current market value except for
the convertible subordinated debt which bears interest at 6.75%.



                             EXPECTED MATURITY DATA


<TABLE>
<CAPTION>
                                                                                                                          FAIR
                                2000         2001         2002        2003         2004      THEREAFTER      TOTAL        VALUE
                              -------      -------      -------      -------      -------    ----------     -------      -------
<S>                           <C>          <C>          <C>          <C>          <C>          <C>          <C>          <C>
Fixed rate debt .......       $   750      $47,158      $    --      $    --      $    --      $48,257      $96,165      $96,165
Average interest rate .          9.15%        9.15%                                               6.75%
Variable rate debt ....       $   612      $   625      $19,864      $   233      $ 4,233      $    --      $25,567      $25,567
Average interest rate .          8.61%        8.66%        8.72%        8.32%        8.05%
</TABLE>



                                       29
<PAGE>   30


        We do not believe that the future market rate risks related to the above
securities will have a material adverse impact on our financial position,
results of operation or liquidity.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

        The consolidated financial statements and the Independent Auditors'
Report are listed at Item 14 and are included beginning on Page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

        None.

                                    PART III

ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT,
                         EXECUTIVE COMPENSATION, SECURITY OWNERSHIP OF CERTAIN
                         BENEFICIAL OWNERS AND MANAGEMENT, AND CERTAIN
                         RELATIONSHIPS AND RELATED TRANSACTIONS

        The information required by these Items is incorporated by reference to
our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of our fiscal year covered by this Report.






                                       30
<PAGE>   31

                                     PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of the report:

        (1)     Financial Statements. The following financial statements of the
                Registrant and the Report of Independent Public Accountants
                therein are filed as part of this Report on Form 10-K:


<TABLE>
<CAPTION>
                                                                                      PAGE
                                                                                      ----
<S>                                                                                   <C>
                Independent Auditors' Report ......................................    F-1
                Consolidated Balance Sheets .......................................    F-2
                Consolidated Statements of Operations .............................    F-3
                Consolidated Statements of Stockholders' Equity ...................    F-4
                Consolidated Statements of Cash Flows .............................    F-5
                Notes to Consolidated Financial Statements ........................    F-7
</TABLE>

        (2)     Financial Statement Schedules. Schedule II-Valuation and
                Qualifying Accounts. Other Financial Statement Schedules have
                been omitted because the information required to be set forth
                therein is not applicable or is shown in the financial
                statements or notes thereto.

(b) Reports on Form 8-K. None.


(c) Exhibits: The following exhibits are filed as part of, or incorporated by
reference into this report on Form 10-K:


<TABLE>
<CAPTION>
     EXHIBIT
      NUMBER          DESCRIPTION
      ------          -----------
<S>                  <C>
        23            Consent of KPMG LLP.

        27            Financial Data Schedule.
</TABLE>




                                       31
<PAGE>   32


                                   SIGNATURES



        Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, as amended, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.



                                   ARV ASSISTED LIVING, INC.

                                   By:    /s/ DOUGLAS M. PASQUALE
                                       ----------------------------------------
                                               Douglas M. Pasquale
                                       President and Chief Executive Officer

Date: March 30, 2000

        Pursuant to the requirements of the Securities Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
                      SIGNATURE                                      TITLE                                     DATE
                      ---------                                      -----                                     ----
<S>                                                 <C>                                                  <C>
       /s/       DOUGLAS M. PASQUALE                President and Chief Executive Officer                 March 30, 2000
-----------------------------------------------     (Principal Executive Officer)
                 Douglas M. Pasquale

       /s/         ABDO H. KHOURY                    Senior Vice President and Chief Financial Officer    March 30, 2000
-----------------------------------------------      (Principal Financial & Accounting Officer)
                   Abdo H. Khoury

       /s/          JOHN A. MOORE                    Director                                             March 30, 2000
-----------------------------------------------
                    John A. Moore

       /s/        DAVID P. COLLINS                   Director                                             March 30, 2000
-----------------------------------------------
                  David P. Collins

       /s/        MAURICE J. DEWALD                  Director                                             March 30, 2000
-----------------------------------------------
                  Maurice J. DeWald

       /s/        JEFFREY KOBLENTZ                   Director                                             March 30, 2000
-----------------------------------------------
                  Jeffery Koblentz
</TABLE>




                                       32
<PAGE>   33

                          INDEPENDENT AUDITORS' REPORT



The Board of Directors
ARV Assisted Living, Inc.:

      We have audited the accompanying consolidated balance sheets of ARV
Assisted Living, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the two-year period ended December 31, 1999, and
the nine-month period ended December 31, 1997. In connection with our audits of
the consolidated financial statements, we have also audited the financial
statement schedule described in Item 14(a)(2). These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.

      We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of ARV Assisted
Living, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the years in the two-year
period ended December 31, 1999, and the nine-month period ended December 31,
1997, in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.



                                             /s/ KPMG LLP

Orange County, California
March 2, 2000



                                      F-1
<PAGE>   34

                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1999 AND 1998
                                 (IN THOUSANDS)

                                     ASSETS



<TABLE>
<CAPTION>
                                                                      1999              1998
                                                                    ---------         ---------
<S>                                                                 <C>               <C>
Current assets:
  Cash and cash equivalents ................................        $  14,570         $  11,885
  Accounts receivable and amounts due from affiliates ......            2,165             1,469
  Prepaids and other current assets ........................            2,772             5,231
  Properties held for sale, net ............................            4,301            35,211
                                                                    ---------         ---------
          Total current assets .............................           23,808            53,796
Property, furniture and equipment ..........................          102,185           105,636
Goodwill, net ..............................................           19,430            23,169
Operating lease security deposits ..........................           12,164             5,764
Other non-current assets ...................................           15,700            17,092
                                                                    ---------         ---------
                                                                    $ 173,287         $ 205,457
                                                                    =========         =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable .........................................        $   1,503         $   5,220
  Accrued liabilities ......................................           10,270            11,644
  Notes payable, current portion ...........................            1,363            21,669
  Accrued interest payable .................................            1,292             1,677
  Net current liabilities from discontinued operations .....            2,510             1,895
                                                                    ---------         ---------
          Total current liabilities ........................           16,938            42,105
Notes payable, less current portion ........................          114,369            88,175
Lease liabilities ..........................................            1,922             1,326
Other non-current liabilities ..............................              934               974
                                                                    ---------         ---------
                                                                      134,163           132,580
                                                                    ---------         ---------

Minority interest in majority owned entities ...............               --             7,190

Stockholders' equity:
Series A Preferred stock, convertible and redeemable; 2,000
  shares authorized, none issued or outstanding at December
  31, 1999 and 1998 ........................................               --                --
  Preferred stock, no par value. 8,000 shares authorized,
     none issued and outstanding ...........................               --                --
  Common stock, .$0.01 par value. Authorized 100,000 shares;
     16,679 and 15,873 shares issued and outstanding at
     December 31, 1999 and 1998, respectively ..............          144,280           143,178
  Accumulated deficit ......................................         (105,156)          (77,491)
                                                                    ---------         ---------
          Total stockholders' equity .......................           39,124            65,687
                                                                    ---------         ---------

Commitments and contingent liabilities                              $ 173,287         $ 205,457
                                                                    =========         =========
</TABLE>



          See accompanying notes to consolidated financial statements.



                                      F-2
<PAGE>   35

                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
        FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND THE NINE-MONTH
                         PERIOD ENDED DECEMBER 31, 1997
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)



<TABLE>
<CAPTION>
                                                                                                                       Nine-Month
                                                                                   Year Ended        Year Ended        Period Ended
                                                                                   December 31,      December 31,      December 31,
                                                                                      1999              1998               1997
                                                                                   ------------      ------------      ------------
<S>                                                                                <C>              <C>              <C>
Revenue:
  Assisted living community revenue:
     Rental revenue ........................................................       $ 110,980        $ 103,402        $  64,411
     Assisted living and other services ....................................          26,196           23,907           12,476
     Management fees .......................................................           1,003            1,116              388
                                                                                   ---------        ---------        ---------
          Total revenue ....................................................         138,179          128,425           77,275
                                                                                   ---------        ---------        ---------
Operating expenses:
  Assisted living community operating expense ..............................          87,665           81,488           49,411
  Assisted living community lease expense ..................................          32,239           26,628           15,773
  General and administrative ...............................................          13,965           27,181           17,595
  Impairment loss ..........................................................          16,368           22,727               --
  Depreciation and amortization ............................................           8,531            9,561            4,896
                                                                                   ---------        ---------        ---------
          Total operating expenses .........................................         158,768          167,585           87,675
                                                                                   ---------        ---------        ---------

Loss from operations .......................................................         (20,589)         (39,160)         (10,400)
                                                                                   ---------        ---------        ---------

Other income (expense):
  Interest income ..........................................................           1,027            2,276            1,821
  Other income (expense), net ..............................................             376              198              321
  Gain (loss) on sale of properties ........................................              --             (674)           5,511
  Interest expense .........................................................          (8,933)          (7,728)          (4,568)
  Litigation judgment ......................................................          (4,368)              --               --
                                                                                   ---------        ---------        ---------
          Total other income (expense) .....................................         (11,898)          (5,928)           3,085
                                                                                   ---------        ---------        ---------

Loss from continuing operations before income tax expense, minority interest
  in income of majority owned entities, extraordinary item, discontinued
  operations and change in accounting principle ............................         (32,487)         (45,088)          (7,315)

Income tax expense .........................................................              35               54              484
                                                                                   ---------        ---------        ---------

Loss from continuing operations before minority interest in income of
  majority owned entities, extraordinary item, discontinued operations
  and change in accounting principle .......................................         (32,522)         (45,142)          (7,799)

Minority interest in income of majority owned entities .....................             903              839              773
                                                                                   ---------        ---------        ---------

Loss from continuing operations before  extraordinary item, discontinued
  operations and change in accounting principle ............................         (33,425)         (45,981)          (8,572)

Extraordinary gain from early extinguishment of debt, net of income tax ....           7,020               --               --
                                                                                   ---------        ---------        ---------

Loss before discontinued operations and cumulative effect of
  change in accounting principle ...........................................         (26,405)         (45,981)          (8,572)

Loss from operations of discontinued operations, net of income tax .........              --               --          (13,563)
Cumulative effect of change in accounting principle, net of income tax .....          (1,260)              --               --
                                                                                   ---------        ---------        ---------

Net loss ...................................................................       $ (27,665)       $ (45,981)       $ (22,135)
                                                                                   =========        =========        =========

Loss per share information: Loss before extraordinary gain from early
  extinguishment of debt, discontinued operations, and cumulative effect of
  change in accounting principle ...........................................       $   (2.09)       $   (2.90)       $   (0.77)
  Extraordinary gain from early extinguishment of debt, net of  income tax .             .44               --               --
  Loss from operations of discontinued operations, net of income tax .......              --               --            (1.21)
  Cumulative effect of change in accounting principle, net of income tax ...            (.08)              --               --
                                                                                   ---------        ---------        ---------
       Net loss ............................................................       $   (1.73)       $   (2.90)       $   (1.98)
                                                                                   =========        =========        =========

Weighted average common shares outstanding .................................          15,968           15,866           11,171
                                                                                   =========        =========        =========
</TABLE>



          See accompanying notes to consolidated financial statements.


                                      F-3
<PAGE>   36

                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
               FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
                  THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                   COMMON STOCK
                                                            -------------------------       ACCUMULATED
                                                             SHARES           AMOUNT          DEFICIT           TOTAL
                                                            ---------       ---------        ---------        ---------
<S>                                                         <C>             <C>              <C>              <C>
Balance at March 31, 1997 ...........................       $   9,655       $  60,749        $  (9,375)       $  51,374
Issuance of common stock, net issuance cost of $4,792           6,193          82,196               --           82,196
Net loss ............................................              --              --          (22,135)         (22,135)
                                                            ---------       ---------        ---------        ---------
Balance at December 31, 1997 ........................          15,848         142,945          (31,510)         111,435
Issuance of common stock ............................              25             233               --              233
Net loss ............................................              --              --          (45,981)         (45,981)
                                                            ---------       ---------        ---------        ---------
Balance at December 31, 1998 ........................          15,873         143,178          (77,491)          65,687
Issuance of common stock ............................             806           1,474               --            1,474
Adjustment to stock issuance cost-litigation
  judgment ..........................................              --            (372)              --             (372)
Net loss ............................................              --              --          (27,665)         (27,665)
                                                            ---------       ---------        ---------        ---------
Balance at December 31, 1999 ........................       $  16,679       $ 144,280        $(105,156)       $  39,124
                                                            =========       =========        =========        =========
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      F-4
<PAGE>   37

                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
               FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND
                  THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)



<TABLE>
<CAPTION>
                                                                                                                     Nine-Month
                                                                                   Year Ended       Year Ended       Period Ended
                                                                                   December 31,     December 31,     December 31,
                                                                                       1999             1998             1997
                                                                                   ------------     ------------     ------------
<S>                                                                                 <C>              <C>              <C>
Cash flows provided by (used in) operating activities:
  Net loss ..................................................................       $ (27,665)       $ (45,981)       $ (22,135)
  Adjustments to reconcile net loss to net cash provided
     by (used in) operating activities:
     Impairment loss ........................................................          16,368           22,727               --
       Extraordinary gain on debt retirement ................................          (7,020)              --               --
     Change in accounting principle .........................................           1,260               --               --
     Loss from discontinued operations ......................................              --               --           13,563
     Loss (gain) on sale of properties ......................................              --              674           (5,511)
     Depreciation and amortization ..........................................           8,531            9,561            4,896
     Provision for discontinued project costs ...............................              --              644              597
     Minority interest in income of majority owned entities .................             903              839              773
     Other ..................................................................              70              (35)            (277)
     Changes in assets and liabilities, net of acquisitions:
       (Increase) decrease in:
          Fees receivable and other amounts due from affiliates .............            (696)            (546)             300
          Deferred tax asset ................................................              --               --              518
          Prepaids and other assets .........................................           2,460           (1,743)             (63)
          Other non-current assets ..........................................            (407)          (1,382)              --
       Increase (decrease) in:
          Accounts payable and accrued liabilities ..........................          (4,091)           4,734            4,329
          Deferred revenue ..................................................              --               --             (166)
          Due to affiliates .................................................              --               --              (40)
          Accrued interest payable ..........................................            (385)             195             (459)
          Lease concessions .................................................             596              781              565
                                                                                    ---------        ---------        ---------
          Net cash provided by (used in) operating activities of
            Continuing operations ...........................................         (10,076)          (9,532)          (3,110)
          Net cash provided by (used in) operating activities of
            Discontinued operations .........................................             615           (3,429)          (4,328)
                                                                                    ---------        ---------        ---------
          Net cash provided by (used in) operating activities ...............          (9,461)         (12,961)          (7,438)
                                                                                    ---------        ---------        ---------
Cash flows provided by (used in) investing activities:
  Acquisition of Hillsdale communities ......................................              --          (71,709)              --
  Payments of deferred project costs ........................................              --             (258)            (128)
  Proceeds from the sale of communities, net of cost ........................          39,786               --               --
  Purchase of previously leased communities .................................         (14,693)              --               --
  Proceeds from sale and leaseback of communities ...........................              --               --            1,871
  Additions to property, furniture and equipment ............................          (7,391)         (12,251)         (18,619)
  (Increase) decrease in leased property security deposits ..................          (6,400)          (1,286)           1,424
  Purchase of limited partnership interests .................................              --               --             (524)
  Proceeds from sale of LLC interests .......................................              --               --           24,253
  Cash contributed to joint venture .........................................          (1,251)              --               --
  Proceeds from sale of communities to joint venture ........................              --            7,249               --
  Distributions received from limited partnership ...........................              --              660            3,570
  Other .....................................................................              --             (527)              --
                                                                                    ---------        ---------        ---------
          Net cash provided by (used in) investing activities ...............          10,051          (78,122)          11,847
                                                                                    ---------        ---------        ---------
Cash flows provided by financing activities:
  Borrowings under notes payable for purchase of previously lease communities          14,677               --               --
  Borrowing under refinancing for owned communities .........................          41,819               --               --
  Proceeds from issuance of common stock, net of issuance costs .............              --              233           24,806
  Borrowings under notes payable ............................................           2,609            4,350               --
  Repayments of notes payable ...............................................         (45,197)            (704)          (1,560)
  Repayments of subordinated debt ...........................................          (1,010)              --               --
  Distributions paid from majority owned entities ...........................          (9,039)            (817)            (688)
  Loan Fees .................................................................          (1,764)              --               --
  Proceeds from convertible subordinated notes, net of issuance costs .......              --               --           60,000
  Payment of costs associated with the conversion of subordinated notes .....              --           (2,610)              --
  Other .....................................................................              --             (260)              --
                                                                                    ---------        ---------        ---------
          Net cash provided by financing activities .........................           2,095              192           82,558
                                                                                    ---------        ---------        ---------
          Net increase (decrease) in cash and cash equivalents ..............           2,685          (90,891)          86,967
Cash and cash equivalents at beginning of period ............................          11,885          102,776           15,809
                                                                                    ---------        ---------        ---------
Cash and cash equivalents at end of period ..................................       $  14,570        $  11,885        $ 102,776
                                                                                    =========        =========        =========
</TABLE>



                                      F-5
<PAGE>   38


<TABLE>
<CAPTION>
                                                                                                                     Nine-Month
                                                                                   Year Ended       Year Ended       Period Ended
                                                                                   December 31,     December 31,     December 31,
                                                                                       1999             1998             1997
                                                                                   ------------     ------------     ------------
<S>                                                                                 <C>              <C>              <C>
  Supplemental schedule of cash flow information:
     Cash paid during the year for:
     Interest ...............................................................       $   9,318        $   9,097        $   6,351
                                                                                    =========        =========        =========
     Income taxes ...........................................................       $      35        $      54        $      14
                                                                                    =========        =========        =========

Supplemental schedule of non-cash investing and financing activities:
     Conversion of current liability to long-term debt ......................       $   1,000        $      --        $      --
     Additional costs of private placement ..................................             372               --               --
     Conversion of subordinated notes to common stock .......................           1,474               --               --
     Assumption of debt in connection with the Hillsdale acquisition ........              --           15,250               --
     Financing of leased property security deposits .........................              --            2,625               --
     Accrual costs associated with the conversion of subordinated notes .....              --               --            2,610
     Conversion of convertible subordinated notes to common stock ...........              --               --           60,000
</TABLE>




          See accompanying notes to consolidated financial statements.



                                      F-6
<PAGE>   39

                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        YEARS ENDED DECEMBER 31, 1999 AND
             1998 AND THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997



(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

GENERAL

        ARV Assisted Living, Inc. and subsidiaries (the "Company") own, operate,
acquire and develop assisted living communities that provide housing to senior
citizens, some of whom require assistance with the activities of daily living
such as bathing, dressing and grooming.

        At December 31, 1999, we operated 58 assisted living communities
("ALCs") in 10 states including 15 which we own ("Owned ALCs"), 36 which we
operate pursuant to long-term operating leases ("Leased ALCs") and seven in
which we serve as the property manager ("Managed ALCs"). Thirty-nine of the ALCs
are located in California. We also managed 9 affordable senior and multifamily
apartments (the "Apartment Group"), in 7 of which we serve as the general
partner. However, in December 1997, our Board of Directors adopted a plan to
discontinue the operations of the Apartment Group. In the latter part of 1998
the Company decided to focus its efforts on the western United States.
Consequently, many assets outside of the western United States have been sold or
written down to their fair value less costs to sell.

CHANGE IN FISCAL YEAR

        We changed our fiscal year end to December 31, from March 31, effective
with the period ending December 31, 1997.

PRINCIPLES OF CONSOLIDATION

        The consolidated financial statements include the accounts of the
Company and its subsidiaries. Subsidiaries, which include limited partnerships
and limited liability companies in which we have controlling interests, have
been consolidated into the financial statements. All significant intercompany
balances and transactions have been eliminated in consolidation.

USE OF ESTIMATES

        In the preparation of our financial statements in conformity with
generally accepted accounting principles, we have made estimates and assumptions
that affect the following:

        -       reported amounts of assets and liabilities at the date of the
                financial statements;

        -       disclosure of contingent assets and liabilities at the date of
                the financial statements; and

        -       reported amounts of revenues and expenses during the reporting
                period.

        Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

        For purposes of reporting cash flows, we consider all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.

DEFERRED PROJECT COSTS

        Deferred project costs are payments incurred prior to the acquisition of
real property and are capitalized as incurred. These preacquisition costs
primarily include land acquisition, legal and architectural fees, feasibility
study costs and other direct costs



                                      F-7
<PAGE>   40
associated with new ALC developments. Deferred project costs are transferred to
property, furniture and equipment upon the successful acquisition of an assisted
living community or site. If a project is discontinued, any deferred project
costs are expensed.

PROPERTY, FURNITURE AND EQUIPMENT

        Property, furniture and equipment are stated at cost less accumulated
depreciation which is charged to expense on a straight-line basis over the
estimated useful lives of the assets as follows:

<TABLE>
<S>                                                     <C>
       Buildings and improvements ................       27.5 to 35 years
       Furniture, fixtures and equipment .........       3 to 7 years
</TABLE>

        Property, furniture and equipment consisted of the following (in
thousands):


<TABLE>
<CAPTION>
                                                     DECEMBER 31,
                                              --------------------------
                                                 1999             1998
                                              ---------        ---------
<S>                                           <C>              <C>
      Land ............................       $  19,404        $  14,699
      Construction in progress ........              --            3,570
      Buildings and improvements ......          82,043           84,094
      Furniture, fixtures and equipment           9,765           14,612
                                              ---------        ---------
                                              $ 111,212          116,975
      Accumulated depreciation ........          (9,027)         (11,339)
                                              ---------        ---------
                                              $ 102,185        $ 105,636
                                              =========        =========
</TABLE>

        Capitalized interest amounted to $1,004,000 for the year ended December
31, 1998 and $1,065,000 for the nine-month period ended December 31, 1997. There
was no capitalized interest for the year ended December 31, 1999.

GOODWILL

        Goodwill represents the excess of the purchase price of acquired assets
over the estimated fair value of the net tangible assets acquired. Goodwill is
amortized on a straight-line basis over 35 years including accumulated
amortization of $1,048,000 at December 31, 1999 and $430,000 at December 31,
1998.

ACCOUNTING FOR LONG-LIVED ASSETS

        We review our long-lived assets for impairment when events or changes in
circumstances indicate that the carrying amount of the assets may not be
recoverable. In reviewing recoverability, we estimate the future cash flows
expected to result from using the assets and eventually disposing of them. If
the sum of the expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset, an impairment loss is
recognized based upon the asset's fair value. For long-lived assets held for
sale fair value is reduced for costs to sell.

        In December 1999 we decided to sell twelve ALCs outside of the western
United States. This decision was in keeping with our strategy to focus our
efforts on occupancy gains and to lease up ALCs faster. In addition in 1998, our
board of directors decided to sell five Owned ALCs and five development land
sites located outside of California. The fair value of the assets, based upon
the offers we received from potential buyers, was below the carrying amount of
the assets. We recorded an impairment loss of $ 16.4 million in 1999 and $19.8
million in 1998 on properties that did not meet the Company's strategy of
focusing in the western United States and classified them as properties held for
sale. Due to restrictions imposed by a landlord, we are unable to convert the
skilled nursing portion of an existing ALC to dementia care. Because of this,
the projected future cash flows from this ALC are less than carrying value of
the assets; therefore, we recorded a $2.9 million impairment loss in 1998.

INVESTMENTS

         We are the general partner in five limited partnerships, four of which
are consolidated, which operate ALCs and senior apartments (ownership interests
range from less than 1% to 95%). We are also a general partner in 7 tax credit
partnerships (ownership is generally less than 1%). We account for our
investment in one partnership where significant influence exists using the
equity method because we have less than a controlling interest. Other
investments in partnerships are a component of discontinued operations. The SEC
took position that you can't be on the cost method over several years, these are
disc ops. Under the terms of the partnership agreements, profits and losses are
allocated to the general and limited partners in specified ratios. We generally
have unlimited liability for obligations of certain partnerships in which we are
the general partner. Liabilities under these obligations have generally not been
significant. We have unlimited liability under separate guarantees and have
recorded significant provisions for these guarantees (see Note 3).

                                      F-8
<PAGE>   41

      On January 31, 1997, we acquired a 12.8% limited partnership interest in
Senior Income Fund, L.P. ("Senior Income Fund") pursuant to a tender offer for
any and all outstanding limited partnership units in Senior Income Fund. The
partnership is a limited partnership that owned and operated four senior
residential properties. We account for our investment in Senior Income Fund
under the equity method. Effective October 1, 1997, we discontinued the
recognition of income related to this investment following Senior Income Fund's
announced plans to liquidate its assets and receipt of a substantial return of
capital.

        In 1998, we pursued an additional development strategy by entering into
joint ventures ("LLCs") designed to help us finance development and renovation
projects and to mitigate the impact of start-up losses associated with the
opening of newly constructed ALCs. The joint ventures were formed to finance and
manage the substantial renovation of existing ALCs acquired in 1998 in the
Hillsdale transaction and to construct three new communities on land sites we
own. Participants in the joint ventures with us are a third-party investor and a
third-party developer. The LLCs have contracted with the developer to provide
development services to perform the renovation and construction. We will manage
the properties operated by the joint venture for an amount equal to three
percent of gross revenues. We account for our investment in the joint ventures
on the equity method and losses incurred by the LLCs are allocated
disproportionately to the joint venture partners based upon their capital
investment and assumption of risk. We will have an option to purchase the joint
venturer's interest in the LLCs when the ALCs reach stabilization, at a purchase
price that is the greater of fair market value or an amount that generates a
guaranteed internal rate of return on the joint venturer's capital contribution.

INCOME TAXES

        We account for income taxes using the asset and liability method whereby
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. A valuation allowance is
recorded to adjust net deferred tax assets to the amount which management
believes will more likely than not be recoverable. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

REVENUE RECOGNITION

        We recognize rental and assisted living services revenue from owned and
leased communities on a monthly basis as earned. We receive fees for property
management and partnership administration services from managed communities.

ASSISTED LIVING COMMUNITY SALE-LEASEBACK TRANSACTIONS

        Certain communities were sold subject to leaseback provisions. Leases
were structured to ensure they meet the provisions for operating lease
treatment. Gains where recorded were deferred and amortized into income over the
lives of the leases.

GAIN ON SALE OF LLC INTERESTS

        In December 1997, we sold our interest in two limited liability
companies, one of which owned a community in New York and the second of which
owned a parcel of land in New Jersey. As a result of this sale, we recognized a
gain on sale of approximately $5.5 million during 1997.

LOSS PER SHARE

        We utilize Statement of Financial Accounting Standards 128 "Earnings Per
Share", in determining earnings (loss) per share ("EPS"). Basic EPS excludes all
dilution and is based upon the weighted average number of common shares
outstanding during the period. Diluted EPS reflects the potential dilution that
would occur if securities or other contracts to issue common stock were
exercised, or converted into common stock. The effect of potentially dilutive
securities was not included for any of the periods presented as the effect was
antidilutive. Potentially dilutive securities include convertible notes and
stock options which convert to 12,972,313, 4,183,442, and 4,250,546 shares of
common stock for the year ended December 31, 1999 and 1998, and the nine month
period ended December 31, 1997, respectively.



                                      F-9
<PAGE>   42

ACCOUNTING FOR START-UP COSTS

        In April 1998, the Accounting Standards Executive Committee issued
Statement of Position ("SOP") No. 98-5, "Reporting on the Costs of Start-up
Activities," which is effective for fiscal years beginning after December 15,
1998. The SOP provides guidance on the financial reporting of start-up
activities and organizational costs. It requires costs of start-up activities
and organizational costs to be expensed when incurred and, upon adoption, the
write-off as a cumulative effect of a change in accounting principle of any
previously capitalized start-up or organizational costs. We adopted the
provisions of SOP 98-5 in the first quarter of 1999. The carrying amounts of
capitalized start-up costs were approximately $1.3 million.

SEGMENT INFORMATION

        The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information ("SFAS 131"). This standard requires that a
public business enterprise report financial and descriptive information about
its reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
regularly evaluated by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. We evaluate performance and
make resource allocation decisions on a community by community basis.
Accordingly, each community is considered an "operating segment" under SFAS 131.
However, SFAS 131 did not have an impact on the financial statements because the
communities have similar economic characteristics, as defined by SFAS 131, and
meet the criteria for aggregation into one "reportable segment".

RECLASSIFICATIONS

        We have reclassified certain prior period amounts to conform to the
December 31, 1999 presentation.

(2) ACQUISITIONS

HILLSDALE PROPERTIES

        In 1998 we purchased interests in 11 senior housing communities,
including a skilled nursing component in one community, all located in
California, for $83.5 million. The communities acquired are as follows:


<TABLE>
<CAPTION>
                                                                                                              DATE
            COMMUNITY                                  LOCATION                      UNITS                  ACQUIRED
            ---------                                  --------                     ------               --------------
<S>                                                    <C>                         <C>                  <C>
            OWNED
            Golden Creek Inn                           Irvine, CA                      123               April 16, 1998
            Hillcrest Inn                              Thousand Oaks, CA               137               April 16, 1998
            Rossmore House                             Los Angeles, CA                 157               May 4, 1998
            The Berkshire                              Berkley, CA                      81               May 12, 1998
            Encino Hills Terrace                       Encino, CA                       76               July 7, 1998
                                                                                    ------
                      Total owned                                                      574
                                                                                    ------
            LEASED
            Willow Glen Villa                          San Jose, CA                    188               May 18, 1998
            Hillsdale Manor Retirement                 San Mateo, CA                   159               July 2, 1998
              Center(a)
                                                                                    ------
                      Total Owned                                                      347
                                                                                    ------
            MANAGED
            Sterling Court(b)                          San Mateo, CA                   149               April 16, 1998
            Palo Alto Commons                          Palo Alto, CA                   143               April 16, 1998
            San Carlos Retirement Center               San Carlos, CA                   85               April 16, 1998
            The Altenheim                              Oakland, CA                     138               April 16, 1998
                                                                                    ------
                      Total Managed                                                    515
                                                                                    ------
                      Total                                                          1,436
                                                                                    ======
</TABLE>

-------------------

(a)     Includes a skilled nursing center.

(b)     In addition, we acquired a twenty percent (20%) general partnership
        interest in WHW Associates, the fifty percent (50%) general partner of
        Fifty Peninsula Partners, a California limited partnership, which owns
        Sterling Court.



                                      F-10
<PAGE>   43

        We accounted for the above transactions using the purchase method and
paid approximately $71.7 million of the purchase prices from cash on hand and
assumed $15.25 million of existing mortgage financing. The terms of the loans
are as follows:

        -       secured by Golden Creek Inn ($2.25 million) and Hillcrest Inn
                ($13.0 million);

        -       at LIBOR plus 2.50% (Golden Creek Inn) and LIBOR plus 2.25%
                (Hillcrest Inn);

        -       monthly payments of interest only until August 1998 (Golden
                Creek Inn) and October 1998 (Hillcrest Inn);

        -       thereafter, monthly payments of principal and interest based
                upon a 25-year amortization schedule; and

        -       outstanding balance of the loans plus all accrued and unpaid
                interest is due and payable in 2002.

        The purchase price paid in excess of the fair value of identifiable
assets for the owned, leased and managed communities acquired aggregated
approximately $23.6 million.

        The pro forma effect of the above acquisitions for December 31, 1998 and
the nine months ended December 31, 1997, assuming that the transactions occurred
on April 1, 1997, is as follows (dollars in thousands, except per share
amounts):

<TABLE>
<CAPTION>
                                                                                      FOR THE NINE-MONTH
                                                           FOR THE YEAR ENDED            PERIOD ENDED
                                                           DECEMBER 31, 1998            DECEMBER 31, 1997
                                                           -----------------          -------------------
                                                                           (UNAUDITED)
                                                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                                           <C>                          <C>
            Operating revenues ............                   $ 137,349                    $  93,992
            Operating expenses ............                   $ 175,522                    $ 102,960
            Net loss ......................                   $ (45,841)                   $ (21,636)
            Loss per common share .........                   $   (2.89)                   $   (1.94)
</TABLE>

(3) DISCONTINUED OPERATIONS

        In December 1997, our Board of Directors adopted a plan to discontinue
the operations of GeriCare, our therapy business, and the Apartment Group
(previously referred to as Tax Credit Properties). In March 1998, we reached an
agreement to form a strategic alliance with a national provider of physical
rehabilitation services. The alliance offers residents of ARV communities
rehabilitation and wellness care services, and assists those residents to age in
place while allowing us to exit the rehabilitation business. We are in
negotiations with lenders for certain of the Apartment Group's tax credit
partnerships to resolve outstanding issues which would increase the
marketability of the partnerships and are in discussions with several potential
buyers of the Apartment Group's assets. During 1998, we entered into purchase
and sale agreements for the sale of 11 apartment projects. As of December 31,
1999, we have closed on the sale of 10 apartment projects, and have 7 other
apartment projects that we plan to sell by December 31, 2000 once we have
obtained lender's and partner's approval.

        Accordingly, the results of these operations for the nine-month period
ended December 31, 1997, including provisions for impairments of the divisions
assets, future losses from operations, anticipated future operating deficit loan
funding and projected permanent loan financing deficits of $10.6 million, have
been segregated from continuing operations and reported separately in the
statement of operations. The assets and liabilities of these operations have
been reflected in the consolidated balance sheet on a net basis, based
substantially on the original current or long-term classification of such assets
and liabilities. We allocate interest to discontinued operations based on
average advances outstanding at our incremental borrowing rate of 6.75% for the
years ended December 31, 1999 and 1998, and the nine months ended December 31,
1997.

        Operating results from discontinued operations are as follows (in
thousands):


<TABLE>
<CAPTION>
                                                                                 FOR THE
                                                    FOR THE YEARS               NINE-MONTH
                                                  ENDED  DECEMBER 31,           PERIOD ENDED
                                                     1999 AND 1998            DECEMBER 31, 1997
                                                       --------                   --------
<S>                                                    <C>                        <C>
            Revenue ................                   $     --                   $  7,129
            Costs and expenses .....                         --                     19,112
                                                       --------                   --------
            Loss before income taxes                         --                    (11,983)
            Income tax provision
              (benefit) ............                         --                      1,580
                                                       --------                   --------
            Net loss ...............                   $     --                   $(13,563)
                                                       ========                   ========
</TABLE>


                                      F-11
<PAGE>   44

        THE COMPONENTS OF NET ASSETS (LIABILITIES) OF DISCONTINUED OPERATIONS
INCLUDED IN OUR CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, 1999 AND 1998 ARE AS
FOLLOWS:

<TABLE>
<CAPTION>
                                                                              DECEMBER
                                                                      ------------------------
                                                                        1999            1998
                                                                      -------          -------
<S>                                                                   <C>             <C>
            Current:
              Cash ..........................................         $   439          $   405
              Accounts receivable and other .................           2,002            4,378
              Accounts payable and other ....................              --             (524)
              Accrued liabilities ...........................          (4,951)          (6,154)
                                                                      -------          -------
                 Net current liabilities from discontinued
                   operations ...............................          (2,510)          (1,895)
                                                                      -------          -------
              Non-current assets ............................              --               --
                                                                      -------          -------
                 Net liabilities from discontinued operations         $(2,510)         $(1,895)
                                                                      =======           =======
</TABLE>

(4) NOTES PAYABLE

        Notes payable consist of the following at December 31 (in thousands):


<TABLE>
<CAPTION>
                                                                                                1999             1998
                                                                                              --------         --------
<S>                                                                                          <C>               <C>
            Convertible subordinated notes due April 1, 2006 with interest at
            6.75% The notes require semi-annual payments of interest
            and are convertible to common stock at $18.57 per share. The
            notes, offered in a maximum amount of $57,500, may be called by us
            beginning in April 1999 at declining premiums starting at
            110% of the principal amount ............................................         $ 48,257         $ 57,500
            Notes payable, bearing interest at fixed rates between 9.15% and
            9.50%, payable in monthly installments of principal and interest
            totaling $360 collateralized by property, maturities ranging from
            November 2000 through June 2001 .........................................           41,884           18,217
            Notes payable, including notes payable to banks of $5,164 at
            December 31, 1999, bearing interest at floating rates of
            LIBOR (5.8% at December 31, 1999) plus rates between 2.25% and 2.75%
            payable in monthly installments of interest only collateralized by
            Owned ALCs, maturities ranging from August 2002  through March 2004 .....           24,404           28,289
            Notes payable to banks, bearing interest at floating rates
            between prime (8.5% at December 31, 1999) plus rates between 1.0%
            through 2.0%, payable in monthly installments of principal and
            interest totaling $25 due March 2004, collateralized by an ALC and
            our corporate headquarters ..............................................                             5,673
            Notes payable to stockholder bearing interest beginning April
            2001 at 30-day Treasury rate with principle due and payable .............            1,147
            April 2002
            Other -- primarily capitalized equipment leases .........................               39              165
                                                                                              --------         --------
                                                                                               115,731          109,844
            Less amounts currently payable ..........................................            1,362           21,669
                                                                                              --------         --------
                                                                                               114,369         $ 88,175
                                                                                              ========         ========
</TABLE>

        The future annual principal payments of the notes payable at December
31, 1999 are as follows (in thousands):

<TABLE>
<S>                                                         <C>
            2000 ...........................                   1,362
            2001 ...........................                  41,783
            2002 ...........................                  19,864
            2003 ...........................                     233
            2004 ...........................                   4,232
            Thereafter .....................                  48,257
                                                            --------
                                                            $115,731
                                                            ========
</TABLE>

        Due to the failed financing in 1998, we paid a lender approximately $1.7
million of fees for an interest rate lock and $0.2 for loan commitment and other
fees. The lender terminated the loan commitment and underlying interest rate
lock in October 1998 due to adverse market conditions. The lender returned $0.4
million of the interest rate lock fees in January 1999. We included the
remaining $1.5 million of fees in interest expense in the accompanying
consolidated statements of operations. We believe that we are entitled to a full
and complete return of the rate lock fees paid. We are pursuing a return of all
fees and are investigating our legal alternatives to that end; however, there
can be no assurances that additional interest rate lock fees will be recovered.



                                      F-12
<PAGE>   45

        The various debt agreements contain restrictive covenants requiring us
to maintain certain financial ratios, including current ratio, working capital,
minimum net worth, debt-to-equity and debt service coverage, among others. At
December 31, 1999, we were in compliance with debt service covenants.

(5) EMPLOYEE BENEFIT PLANS

ESOP

        We have an Employee Stock Ownership Plan ("ESOP") which covers all of
our employees. Contributions to the ESOP are made at the discretion of our Board
of Directors. For the years ended December 31, 1999 and 1998 and the nine-month
period ended December 31, 1997 there were no contributions. Subsequent to
December 31, 1999 we received notification from the Internal Revenue Service
that we could terminate the ESOP. Final distribution to participants in the ESOP
plan is expected to be completed by March 31, 2000.

SAVINGS PLAN

        Effective January 1, 1997, we established a savings plan (the "Savings
Plan") that qualifies as a deferred salary arrangement under Section 401(k) of
the Internal Revenue Code. Under the Savings Plan, participating employees who
are at least 21 years of age may defer a portion of their pretax earnings, up to
the Internal Revenue Service annual contribution limit. We match 25% of each
employee's contributions up to a maximum of 6% of the employee's earnings.
Employees are eligible to enroll at the first enrollment date following the
start of their employment (July 1 or January 1). We match employees'
contributions beginning on the first enrollment date following one year of
service or 1,000 hours of service. Our expense related to the Savings Plan was
approximately $191,000, $198,000 and $129,000 for the years ended December 31,
1999 and 1998 and the nine-month period ended December 31, 1997, respectively.

(6) STOCK OPTIONS

        The Company has two stock option plans that provide for the granting of
stock options to officers, directors, consultants and key employees. The
objectives of these plans include attracting and retaining the best personnel,
providing for additional performance incentives, and promoting the success of
the Company by providing employees the opportunity to acquire common stock. We
have elected to follow Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25") and related interpretations in
accounting for employee stock options. Under APB 25, because the exercise price
of our employee stock options usually equals the market price of the underlying
stock on the date of grant, no compensation expense is recorded.

        The 1995 Stock Option and Incentive Plan of ARV Assisted Living, Inc. is
two-tiered, one for the benefit of key employees and consultants and one for the
benefit of non-employee directors. The maximum number of shares which may be
issued under the Plan is 15% of the total outstanding shares at the end of the
fiscal year. The number of shares which may be issued for Incentive Stock
Options is limited to 1,155,666 shares. As of December 31, 1999, there are
273,866 Incentive Stock Options available for issuance.

        The 1999 Stock Option Plan of ARV Assisted Living, Inc. is two-tiered
and very similar to our 1995 Stock Option and Incentive plan. The maximum number
of shares which may be issued under the 1999 Plan is 2,400,000 plus 15% of any
increase in total outstanding shares as of June 30, 1999. As of December 31,
1999 there are 118,166 Incentive Stock Options available for issuance. Options
granted under both stock option plans vest over periods ranging from one and
one-half to five years from the date of grant. At December 31, 1999, 121,800 of
the options were eligible for exercise.

        A summary of stock option plans at December 31, 1999 is as follows:


<TABLE>
<CAPTION>
                                                          SHARES UNDER
                                                           OUTSTANDING
                                                             OPTIONS           PRICE PER SHARE
                                                           ----------          ---------------
<S>                                                        <C>                <C>
            AUTHORIZATION OF SHARES ..............          3,555,660                      N/A
            Options granted ......................          2,350,400          $4.75 -- $16.25
            Options exercised ....................            (25,000)         $9.00 -- $10.25
            Options canceled .....................         (1,238,350)         $4.75 -- $15.40
                                                           ----------          ---------------
            Balance at December 31, 1998 .........          1,087,050          $4.75 -- $16.25
            Options granted ......................          1,745,000          $1,63 -- $14.00
            Options exercised ....................                                         N/A
            Options canceled .....................           (937,750)         $3.00 -- $16.25
                                                           ----------          ---------------
            Balance at December 31, 1999 .........          1,894,300          $1.63 -- $15.75
                                                           ==========          ===============
</TABLE>



                                      F-13
<PAGE>   46

        Pro forma information regarding net loss and net loss per share is
required by SFAS 123, which also requires that the information be determined as
if we have accounted for our employee stock options granted subsequent to
December 31, 1994 under the fair value method of SFAS 123. The fair value for
these options was estimated at the date of grant using a Black-Scholes option
pricing model with a weighted-average expected life of the option of 7 years.

        The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. Option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those of trade options, and because changes in subjective input assumptions can
materially affect the fair value estimate, actual fair values may differ from
those estimates.

        The following represents the estimated fair value of stock options
granted and the assumptions used for calculation:


<TABLE>
<CAPTION>
                                                                                                                  NINE-MONTH
                                                                                  YEAR ENDED      YEAR ENDED     PERIOD ENDED
                                                                                  DECEMBER 31,    DECEMBER 31,   DECEMBER 31,
                                                                                     1999            1998            1997
                                                                                  ------------    ------------   ------------
<S>                                                                                 <C>             <C>             <C>
            Average estimated fair value per option at grant date .........         $ 3.00          $11.81          $14.00
            Average exercise price per option granted .....................         $ 3.00          $11.81          $14.07
            Expected Stock volatility .....................................             60%             60%             53%
            Risk -- free interest rate ....................................            5.0%            4.7%            5.7%
            Option term -- years ..........................................             10              10              10
            Stock dividend yield ..........................................             --              --              --
</TABLE>

        For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Our pro forma
information is as follows (in thousands, except per share amounts):


<TABLE>
<CAPTION>
                                                                                               NINE-MONTH
                                                      YEAR ENDED           YEAR ENDED          PERIOD ENDED
                                                      DECEMBER 31,         DECEMBER 31,        DECEMBER 31,
                                                          1999                1998                 1997
                                                       ----------          ----------          ----------
<S>                                                    <C>                 <C>                 <C>
            Pro forma net loss ...............         $  (28,436)         $  (47,362)         $  (23,865)
            Pro forma loss per share .........         $    (1.78)         $    (2.99)         $    (2.14)
</TABLE>

        A summary of our stock option activity and related information for the
years ended December 31, 1999 and 1998 and the nine-month period ended December
31, 1997 is as follows:


<TABLE>
<CAPTION>
                                                  1999                              1998                             1997
                                   -----------------------------     -----------------------------      ---------------------------
                                                WEIGHTED AVERAGE                  WEIGHTED AVERAGE                 WEIGHTED AVERAGE
                                    OPTIONS      EXERCISE PRICE       OPTIONS      EXERCISE PRICE       OPTIONS     EXERCISE PRICE
                                   ---------    ----------------     ---------    ----------------      -------    ----------------
<S>                             <C>              <C>                <C>             <C>              <C>             <C>
Outstanding -- beginning of
  the period ...............       1,087,050      $     13.33        1,038,002      $     13.12         952,892       $     12.82
Granted ....................       1,745,000      $      3.00          847,500      $     11.81         259,500       $     14.07
Exercised ..................                      $        --          (25,000)     $      9.33              --                --
Forfeited ..................        (937,750)     $     10.56         (773,452)     $     11.52        (174,390)      $     12.89
                                   ---------                         ---------                        ---------
Outstanding -- end of period       1,894,300      $      6.46        1,087,050      $     13.33       1,038,002       $     13.12
                                   ---------                         ---------                        ---------
Exercisable at
  end of period ............          96,800      $     12.80          141,350      $     12.62         243,185       $     13.69
Weighted average
  fair value
  of options granted
  during the period ........                      $      3.00                       $     11.81                       $     14.07
                                                  ===========                       ===========                       ===========
</TABLE>


        At December 31, 1999, options outstanding had a weighted average life of
8.85 years.

(7) INCOME TAXES

        The provision for income tax expense from continuing operations consists
of the following for the years ended December 31, 1999 and 1998 and the
nine-month period ended December 31, 1997 (in thousands):



                                      F-14
<PAGE>   47
<TABLE>
<CAPTION>
                                                               FOR THE              FOR THE            NINE-MONTH
                                                             YEAR ENDED            YEAR ENDED          PERIOD ENDED
                                                             DECEMBER 31,          DECEMBER 31,        DECEMBER 31,
                                                                 1999                 1998                 1997
                                                             ------------          ------------        ------------
<S>                                                         <C>                  <C>                  <C>
               Current:
                 Federal ........................                                                         $ (29)
                 State ..........................                  35                   54                   (5)
                                                                -----                -----                -----
                                                                   35                   54                  (34)
                                                                -----                -----                -----
                         Total current
               Deferred:
                 Federal ........................                  --                   --                  440
                 State ..........................                  --                   --                   78
                                                                -----                -----                -----
                         Total deferred .........                  --                   --                  518
                                                                -----                -----                -----
                                                                $  35                $  54                $ 484
                                                                =====                =====                =====
</TABLE>

        We have Federal net operating loss carryforwards of $61,687,000, which
expire in 2011 to 2019.

        A reconciliation of income tax expense (benefit) related to income from
continuing operations to the Federal statutory rate of 34% is as follows (in
thousands):


<TABLE>
<CAPTION>
                                                                               FOR THE YEAR       FOR THE YEAR        NINE-MONTH
                                                                                   ENDED              ENDED          PERIOD ENDED
                                                                                DECEMBER 31,       DECEMBER 31,      DECEMBER 31,
                                                                                   1999               1998               1997
                                                                               -------------      -------------      ------------
<S>                                                                              <C>                <C>                <C>
               Income tax expense (benefit) at statutory Rate .........          $ (9,406)          $(15,330)          $ (2,487)
               State income tax expense, net of Federal income taxes ..                35                 36                 48
               Change in valuation allowance due to change in
                 assumptions at beginning of the year .................                --                 --                440
               Change in federal valuation allowance due to current
                 year losses...........................................             9,339             15,000              3,878
               Fully reserved tax benefits generated by
                 discontinued operations that will benefit
                 continuing operations in the future ..................                --                 --             (1,133)
               Other ..................................................                67                348               (262)
                                                                                 --------           --------           --------
                         Total income tax expense .....................          $     35           $     54           $    484
                                                                                 ========           ========           ========
</TABLE>

        Temporary differences giving rise to a significant amount of deferred
tax assets and liabilities from continuing operations at December 31, 1999 and
1998 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                                            DECEMBER 31,       DECEMBER 31,
                                                                               1999               1998
                                                                            ------------       ------------
<S>                                                                          <C>                <C>
               Deferred tax assets:
                 Deferred gain on sale ............................          $     --           $    120
                 Other partnership income .........................                --                799
                 Net operating loss carryforwards .................            24,760             12,381
                 Write down of properties .........................             9,625              9,044
                 Other ............................................             1,098              1,860
                                                                             --------           --------
                         Gross deferred tax asset .................            35,483             24,204
                 Less valuation allowance .........................           (34,593)           (23,534)
                 Deferred tax liabilities -- other ................              (890)              (670)
                                                                             --------           --------
                         Net long-term deferred tax asset .........          $     --           $     --
                                                                             ========           ========
</TABLE>

        A valuation allowance is provided against net deferred tax assets when
it is more likely than not that some portion of the deferred tax asset will not
be realized. We have established a valuation allowance for the deferred tax
asset as, in our best estimate, it is not likely to be realized in the near
term.

(8) RELATED PARTY TRANSACTIONS

        Fees and other amounts receivable from affiliates of $1,374,000 and
$760,000 at December 31, 1999 and 1998, respectively, consist of receivables
related to management services we rendered and non-interest bearing expense
advances to various partnerships. Amounts due from affiliates are generally
expected to be repaid in subsequent years with cash from operations or from bank
financing obtained by the affiliates. Related management fee revenue from
affiliates totals $722,000, $742,000, and $388,000 during the year ended
December 31, 1999 and 1998 and the nine-month period ended December 31, 1997,
respectively.

        We are reimbursed for certain expenses such as payroll and retirement
benefit, supplies and other small expenses paid on behalf of Affiliated
Partnerships. During the years ended December 31, 1999 and 1998 and the
nine-month period ended December 31, 1997, respectively, the expenses incurred
on behalf of affiliates and the related reimbursements from these affiliates
amounted to approximately $17.8 million, $12.8 million, and $8.6 million,
respectively. We account for these reimbursements as a reduction of the related
expenses.

                                      F-15
<PAGE>   48
        We lease office space under operating leases from affiliated entities
which expire between 2001 and 2003. Total rental expense related to these leases
for the years ended December 31, 1999 and 1998 and the nine-month period ended
December 31, 1997 was $163,000, $163,000, and $112,000, respectively

        To address certain structural issues in connection with tax credit
partnerships, Pacific Demographics Corporation ("Pacific Demographics")
(formerly ARVTC, Inc.), was formed in August 1994 by Mr. Collins, as well as
five other former officers or directors, to provide certain development services
for these partnerships in exchange for cash and deferred development fees
generated by the tax credit partnerships. In order to lessen potential conflicts
of interest, in July 1995, our then principal stockholders, who included but
were not limited to Messrs. Booty, Collins and Espley-Jones sold Pacific
Demographics, Inc. to us for $100,000 in cash. In addition, they formed a
general partnership, Hunter Development ("Hunter"), and became co-developers
with Pacific Demographics and retained the right to receive 20% of all developer
fees up to a maximum of $850,000. Subsequently each of the general partners of
Hunter assigned his interest in Hunter to Redhill Development, LLC. Of the
maximum amount of $850,000 which could be distributed, $300,428 has been
distributed to date of which Messrs. Booty, Collins and Espley-Jones have
received $111,627, $65,714 and $37,153, respectively.

        John A. Booty, our former President and former member of the Board of
Directors, provided us consulting services, between October 1996 and September
1997, for which we paid a varying sum not to exceed $30,000 per month for
development and acquisition consulting services. During the nine-month period
ended December 31, 1997 Mr. Booty was paid $175,000 for consulting services. No
consulting fees were paid to Mr. Booty during the years ended December 31, 1999
and 1998.

        We use the services of J&D Design, as well as others, for interior
design work at our communities. The principal of J&D Design is Joan Davidson,
wife of former Senior Vice President Eric Davidson and daughter-in-law of the
former Chairman, President and Chief Executive Officer, Gary Davidson. Services
provided by J&D Design include design work and the purchase of furniture,
fixtures and equipment ("FF&E") for developed ALCs and rehabilitation of
existing or newly acquired ALCs. We paid J&D Design approximately $13,000,
$560,000, and $755,000 for the years ended December 31, 1999 and 1998 and the
nine-month period ended December 31, 1997, respectively, a portion of which was
for design services and a portion of which was for reimbursement of costs for
FF&E.

        Mr. R. Bruce Andrews, a former member of our Board of Directors, is
President of Nationwide Health Properties, Inc. ("NHP"), a health care REIT. NHP
is the owner of 16 ALCs we lease. Of that number, leases for 13 ALCs were
entered into prior to November 29, 1995, the date Mr. Andrews became a Board
member, and leases for three ALCs were entered into during Mr. Andrews' tenure
as a board member. Aggregate lease payments under these leases were
approximately $10.4 million, $11.3 million, and $8.2 million for the years ended
December 31, 1999 and 1998 and the nine-month period ended December 31, 1997,
respectively.

(9) STOCKHOLDERS' EQUITY

SALE OF SHARES TO PROMETHEUS

        In July 1997, we sold approximately 1.9 million shares of our common
stock to Prometheus Assisted Living LLC ("Prometheus"), an affiliate of Lazard
Freres Real Estate Investors, LLC ("Lazard" or "LFREI") for $26.9 million. In
October 1997, we issued $60 million of Convertible Subordinated Notes (the
"Notes") to Prometheus. The Notes were convertible into approximately 3.5
million shares of our common stock at $17.25 per share. We had the option to
call the Notes at any time, and on December 5, 1997, the Board approved the
redemption of the Notes. Per the terms of the Notes, the redemption was made
through issuance of our common stock. Including a 23.214% optional redemption
premium and accrued interest to date, the issuance amounted to approximately 4.3
million shares. As a result of these two transactions, we raised additional
capital, net of costs, of approximately $82.2 million.

WARRANTS

        At December 31, 1997, we had outstanding warrants issued to selling
brokerage firms in connection with our convertible subordinated notes which give
the holders the option to purchase an aggregate maximum of 116,152 shares of
common stock at $12.16 per share. These warrants were exercisable at any time at
the option of the holder within three years of the date of issuance, the latest
of which was July 31, 1995. As of December 31, 1998, warrants to purchase 28,415
shares of Common Stock were exercised. On June 27, 1999 we issued 72,000
warrants to the lender as part of the refinancing of the 9 ALCs. These warrants
provide for the purchase price of $3.93 per share of common stock of the
company; expiring June 27, 2004.

STOCKHOLDERS RIGHTS PLAN

        In May 1998, we adopted a stockholders rights plan under which we have
declared a dividend distribution of one Preferred Share Purchase Right on each
outstanding share of our common stock. Subject to limited exceptions, the Rights
will be exercisable if a person or group acquires 10% or , in the case of LFREI,
50% or more of our stock or announces a tender offer for 10% or, in the case


                                      F-16
<PAGE>   49

of LFREI, 50% or more of the common stock. When exercisable, each Right (except
the Rights held by the acquiring person) will entitle its holder to purchase, at
the Right's then-current exercise price, a number of our common shares having a
market value at the time of twice the Right's exercisable price. If we are
acquired in a merger or other business combination transaction which has not
been approved by our Board of Directors, each Right will entitle its holder to
purchase, at the Right's then-current exercise price, a number of the acquiring
company's common shares having a market value at that time of twice the Right's
exercise price.

(10) ASSISTED LIVING COMMUNITY LEASES

        At December 31, 1999, we leased 36 ALCs. The ALC leases expire from 2006
to 2017, and contain two to three renewal options ranging from five to ten
years.

        Generally, leases for Leased ALCs owned by a common landlord contain
cross default provisions permitting the lessor to declare a default under all
leases in the event of default on one lease. The lease agreements with each
landlord are interconnected in that we will not be entitled to exercise our
right to renew one lease with a particular landlord without exercising our right
to renew all other leases with that landlord. Also, leases with each landlord
contain certain cross default provisions. Therefore, in order to exercise all
lease renewal terms, we will be required to maintain and rehabilitate the Leased
ALCs on a long-term basis. We anticipate that similar renewal and cross-default
provisions will be included in leases with other landlord.

        Minimum lease payments required under assisted living community
operating leases in effect at December 31, 1999 are as follows:



<TABLE>
<CAPTION>
               YEAR ENDED DECEMBER 31:                                  (IN THOUSANDS)
               -----------------------                                  --------------
<S>                                                                        <C>
               2000 .............................................          $ 31,723
               2001 .............................................            32,118
               2002 .............................................            32,637
               2003 .............................................            33,029
               2004 .............................................            33,001
               Thereafter .......................................           241,269
                                                                           --------
                                                                           $403,777
                                                                           ========
</TABLE>

        Certain of the leases require the payment of additional rent based on a
percentage increase of gross revenues. Leases are subject to increase based upon
changes in the consumer price index or gross revenues, subject to certain
limits, as defined in the individual lease agreements.

(11) LIQUIDITY

        We believe that our existing liquidity, ability to sell assisted living
communities and land sites which do not meet our financial objectives or
geographic clustering strategy, and ability to refinance certain assisted living
communities will provide adequate resources to meet our current operating and
investing needs and support our current growth plans for the next 12 months. We
do not currently generate sufficient cash from operations to fund recurring
working capital requirements. We will be required from time to time to incur
additional indebtedness or issue additional debt or equity securities to finance
our growth strategy, including the acquisition and development of assisted
living communities as well as other capital expenditures and to provide
additional funds to meet increased working capital requirements.

(12) COMMITMENTS AND CONTINGENT LIABILITIES

COMMITMENTS

        We have guaranteed the indebtedness at December 31, 1999, of certain
affiliated partnerships as follows:

<TABLE>
<CAPTION>
                                                                                (IN THOUSANDS)
                                                                                --------------
<S>                                                                                <C>
               Notes secured by real estate ..............................          $70,024
               Land and construction loans associated with the development
                 and construction of affordable housing apartments .......          $20,265
</TABLE>

The maximum aggregate amount of guaranteed indebtedness is $90.3 million at
December 31, 1999. We have guaranteed tax credits for certain partnerships in
the aggregate amount of $65.3 million, excluding interest, penalties or other
charges which might be assessed against the partners. We have provided
development and operating deficit guarantees for certain Affiliated
Partnerships. In December 1997, our Board of Directors adopted a plan to
discontinue operations of the Apartment Group. As of December 31, 1999,



                                      F-17

<PAGE>   50

we have a $5.3 million accrual from the original $8.6 million charge for
development and operating deficit guarantees and permanent loan shortfalls
recorded in December 31, 1997 for these discontinued operations.

        In our opinion, no claims may be currently asserted under any of the
aforementioned guarantees based on the terms of the respective agreements other
than those accrued.

        At December 31, 1999, we leased office space under various operating
leases expiring from 2001 to 2003, some of which are from affiliated entities
(see Note 8). Non-cancelable operating lease commitments for office space at
December 31, 1999 are:


<TABLE>
<CAPTION>
               YEAR ENDED DECEMBER 31:                           (IN THOUSANDS)
               -----------------------                           --------------
<S>                                                                 <C>
               2000 ........................................          $125
               2001 ........................................           120
               2002 ........................................           124
               2003 ........................................           128
               Thereafter ..................................            --
                                                                      ----
                         Total .............................          $497
                                                                      ====
</TABLE>

        Rent expense for all leased office space amounted to $163,000, $474,000,
and $257,000 for the years ended December 31, 1999 and 1998, and the nine-month
period ended December 31, 1997, respectively.

CONTINGENCIES

        A lawsuit was filed on April 24, 1998, in the Superior Court of
California, County of Orange, alleging that share purchases on January 16, 1998,
by Prometheus Assisted Living LLC, triggered the Company's Shareholder Rights
Agreement. On June 30, 1999, the trial judge issued a statement of decision
against ARV and in favor of Emeritus in the amount of $5.4 million. This lawsuit
accrual was recorded in other expense. On September 29, 1999, Emeritus agreed to
settle the action providing for a cash payment of $1.5 million and a note for
$3.5 million as payment in full. The note was paid by February 2000 and Emeritus
accepted a total of $4.3 million as the total settlement payment. Since the note
payable was non-interest bearing, a 12% imputed interest discount was booked in
litigation judgement expense for $0.6 million. No final judgment was entered and
the lawsuit was dismissed.

        On May 12, 1998, we filed a lawsuit in the Superior Court for the State
of California, County of Orange, seeking to enjoin Kapson Senior Quarters Corp.
("Kapson"), a controlled affiliate of Lazard Freres Real Estate Investors LLC
("LFREI,") from acquiring Atria Communities ("Atria"), a then unaffiliated
competitor. Atria was also named as a defendant in the suit, as were three LFREI
representatives on our Board of Directors, Messrs. Kenneth M. Jacobs, Robert P.
Freeman and Murry N. Gunty. We alleged that LFREI was violating both its
contractual and fiduciary duties to ARV if it allowed Kapson to proceed with the
acquisition without first offering ARV the right to acquire Atria and then, if
we declined, obtaining our permission to consummate the acquisition of Atria. On
August 14, 1998, the Judge in the trial ruled from the bench against ARV and in
favor of all defendants on LFREI's motion for judgment on all of our causes of
action. And, on December 7, 1998, the Superior Court of the State of California,
County of Orange issued an order in favor of LFREI on LFREI's cross-complaint
against us, concluding that LFREI's standstill obligations under its
stockholders agreement with ARV terminated as of April 1998. Final judgment in
the action was entered on May 12, 1999. We filed a notice of appeal in July 1999
with the Superior Court for the State of California, County of Orange.

        On December 18, 1998, Prometheus filed a lawsuit in the Delaware
Chancery Court against us and two of our former directors, Howard G. Phanstiel
and John A. Booty. The lawsuit sought a determination that our annual meeting of
stockholders held in June 1998 was invalid because of an alleged failure to
reach a quorum and, accordingly, that the actions taken at that meeting were
invalid.

        On September 29, 1999 LFREI affiliated with Prometheus agreed to settle
these actions and accept a promissory note for $1.5 million as full satisfaction
of its claims, $0.4 million of which has been recorded as additional private
placement costs. This note will bear interest beginning on April 1, 2001 at a
rate equal to the 30 day Treasury bill rate quoted by the Wall Street Journal.
Interest payments will be made on the first day of each month beginning on May
1, 2001 and continue until maturity of the note on April 1, 2002. In the event
of default, the note is immediately due and payable and interest shall accrue at
a rate that is 4% above the interest rate otherwise in effect. Because the note
payable is non-interest bearing, a 12% imputed interest discount was used in
recording the obligation. We have the right at any time to prepay the Note in
whole or in part. Any time prior to November 1, 1999 the prepayment price is
equal to 91% of the aggregate principal balance. Such prepayment price shall
increase by 0.5% of the aggregate principal amount of the Note on the 10th day
of each month thereafter until April 1, 2002.


                                      F-18

<PAGE>   51

        The agreement settled all outstanding litigation between us and LFREI
and provided mutual release of certain claims that we and Prometheus may have
had against each other. Pursuant to the settlement agreement, we withdrew our
appeal of the decision issued on May 12, 1999 by the Superior Court of the State
of California, County of Orange. Prometheus dismissed the lawsuit it filed
against us and two of our former directors in the Delaware Chancery Court. As
part of the settlement agreement, the board of directors was reduced to five
persons. Murry N. Gunty, John A. Booty and Robert P. Freeman resigned from the
board.

        On June 15, 1999, six California limited partnerships of which the
Company is the managing general partner and a majority limited partner -
American Retirement Villas Properties II, American Retirement Villas Properties
III, Casa Bonita Fullerton, Ltd., Collwood Knolls, L.P., and San Gabriel
Retirement Villa, L.P. (the "ARV Partnerships")-filed an action in the Superior
Court for the State of California, County of Orange, seeking a declaratory
judgment and damages for breach of contract, promissory estoppel, fraud and
negligent misrepresentation against PRN Mortgage Capital, L.L.C. and Red
Mountain Funding, L.L. C. (the "Defendants").

        The parties are in the initial states of discovery. Defendants have not
filed a counter-claim, but have threatened in verbal communications to seek
payment by the ARV Partnerships of certain loan commitment fees allegedly owed
to Defendants. The ARV Partnerships believe that they have substantial and
meritorious defenses to the counter-claims threatened by Defendants.

        We are from time to time subject to lawsuits and other matters in the
normal course of business. While we cannot predict the results with certainty,
we do not believe that any liability from any such lawsuits or other matters
will have a material effect on our financial position, results of operations, or
liquidity.

(13) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS

        The estimated fair value of our financial instruments have been
determined using available market information and appropriate valuation
methodologies. However, considerable judgment is necessarily required to
interpret market data to develop the estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts that
could be realized in a current market exchange. The use of different market
assumptions or estimation methodologies may have a material impact on the
estimated fair value amounts.

         The carrying amounts reported in the consolidated balance sheets for
cash and cash equivalents, fees receivable and other amounts due from affiliates
and, accounts payable, accrued liabilities and accrued interest payable,
approximate fair value due to the short-term nature of these instruments. The
notes payable bear interest at rates and other terms that approximate current
market rates and terms. Therefore, we believe that the carrying value
approximates fair value, except for convertible debt which is approximately
$13.5 million at December 31, 1999.

(14) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)



<TABLE>
<CAPTION>
                                                                               FOR THE QUARTER ENDED
                                                         ---------------------------------------------------------------------
                                                         DECEMBER 31        SEPTEMBER 30           JUNE 30            MARCH 31
                                                         -----------        ------------           -------            --------
                                                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                       <C>                 <C>                 <C>                 <C>
               1999
               Total revenue ..................           $ 34,060            $ 34,024            $ 34,344            $ 35,758
               Loss from operations ...........            (10,632)               (713)             (1,203)             (8,041)
               Net loss .......................             (5,513)             (2,433)            (15,693)             (4,026)
               Basic and diluted loss per share              (0.34)              (0.15)              (0.99)              (0.25)
               1998
               Total revenue ..................           $ 35,100            $ 35,052            $ 30,946            $ 27,327
               Loss from operations ...........            (29,530)             (3,871)             (3,091)             (2,668)
               Net loss .......................            (32,916)             (5,607)             (4,443)             (3,015)
               Basic and diluted loss per share              (2.08)              (0.35)              (0.28)              (0.19)
</TABLE>

FOURTH QUARTER TRANSACTIONS AND ADJUSTMENTS

         In December 1999, we received letters of intent to purchase the twelve
leased ALCs located outside of the western United States, an impairment loss of
$8.6 million was recorded. Additionally in the fourth quarter we began a program
to retire our convertible subordinated debt before it maturity date in 2006.
During 1999 we retired $9.2 million in debt for 799,566 shares of common stock
and $1.0 million in cash resulting in a $6.8 million extraordinary gain. The
remaining $0.2 million was due to debt retired on an assets held for sale.


                                      F-19

<PAGE>   52

        In December 1998, our board of directors decided to sell five owned
assisted living communities and five development land sites located outside of
California, our primary geographic focus. The fair value of the assets, based
upon the offers we received from potential buyers, was below the carrying amount
of the assets. We recorded an impairment loss of $19.0 million on these
properties and classified them as properties held for sale. The projected future
cash flows from four assisted living communities are less than carrying value of
the assets; therefore, we recorded a $3.7 million impairment loss. Additionally,
during the fourth quarter in the year ended December 31, 1998, we recorded an
accrual for litigation exposure related to our lawsuits with LFREI totaling $1.0
million and severance costs incurred in connection with the resignation of two
senior executives of $1.2 million.

        The operating results for the final quarter in the nine-month period
ended December 31, 1997, include the expenses incurred in connection with our
proxy contest with Emeritus Corporation of $1.6 million, severance costs of $1.1
million incurred in connection with the retirement of two senior executives
which were approved by our Compensation Committee in December 1997, the
write-off of $1.1 million of costs incurred in connection with the accounting
software conversion, which was abandoned in February 1998 upon discovering
numerous application errors in the software package purchased, and an impairment
provision of $150,000 following Senior Income Fund's announced plans to
liquidate its assets and receipt of a substantial return of capital.

(15) SUBSEQUENT EVENTS

        The Company began retiring portions of our 6 3/4% convertible
subordinated debt during 1999. Subsequent to December 31, 1999 the Company has
continued to retire additional bonds for a total of $7.8 million principal
amount resulting in a $5.6 million extraordinary gain, net of tax. Through these
transactions, we have retired a total of $17.1 million of our public debt
yielding extraordinary gains of $12.4 million to date.


                                      F-20
<PAGE>   53


                            ARV ASSISTED LIVING, INC.
                                AND SUBSIDIARIES

                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                 FOR THE YEARS ENDED DECEMBER 31, 1999, AND 1998
                AND THE NINE MONTH PERIOD ENDED DECEMBER 31, 1997
                                 (IN THOUSANDS)




<TABLE>
<CAPTION>
                                         BALANCE AT                                                       BALANCE AT
DESCRIPTION                          BEGINNING OF YEAR         ADDITIONS             DEDUCTIONS           END OF YEAR
-----------                          -----------------         ---------             ----------           -----------
<S>                                      <C>                   <C>                   <C>                   <C>
Allowance for Other Assets:
  December 31, 1997 .......               $   113               $    90               $   203               $    --
  December 31, 1998 .......                    --                   376                    68                   308
  December 31, 1999 .......                   308                   212                    31                   489
Discontinued operations:
  December 31, 1997 .......                 3,249                11,212                 1,640                12,821
  December 31, 1998 .......                12,821                   645                 1,857                11,609
  December 31, 1999 .......                11,609                   326                 1,694                10,241
</TABLE>




                 See accompanying independent auditors' report.

<PAGE>   54


                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER           DESCRIPTION
------           -----------
<S>             <C>
 23              Consent of KPMG LLP.

 27              Financial Data Schedule.
</TABLE>